Beyond Bulls & Bears

Equity

We’re Finally Putting Brexit to Bed—What’s Next for UK Equities?

It could be the beginning of the end for some factors that have clouded the UK equity market outlook, according to Franklin UK Equity team’s Colin Morton. Here, he weighs in on why clarity on Brexit nurtures his cautious optimism for UK stocks.

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While some of 2019’s geopolitical tensions remain across the globe, one positive development is that we’re finally putting Brexit to bed.

After three and a half years, the United Kingdom has officially left the European Union (EU). We will now head into uncharted territory of EU negotiations, only this time, to discuss the shape of the UK-EU future relationship in an official transition period. We should start to gain some clarity on elements that previously clouded our outlook for UK stocks.

By the end of 2019, we saw much stronger equity returns than most prognosticators had anticipated—the FTSE 100 Index finished the year up 12%, while the FTSE 250 Index finished up 24%.1 We’d expect to gain more clarity on the direction of mid and large-capitalisation stocks as post-Brexit events play out over the year.

In our view, low interest rates globally remain a tailwind for equities—the US Federal Reserve cut rates three times in 2019, while the European Central Bank notably cut interest rates to a record low of -0.5% last September. Combined with easy monetary policy, we think there’s much more fiscal headroom in 2020 that should likely support European stocks, and notably UK stocks. We’ve already seen some governments start fiscal spending programmes to boost ailing economies. For example, the French government has committed €10 billion of tax cuts for its 2020 budget to boost investment and consumer confidence.

That said, we would want to pare down investor expectations for a remarkably stronger year in 2020. While it’s unlikely there will be headline-grabbing equity opportunities, we think we can find some interesting opportunities that aren’t specific to particular sectors or industries in the year ahead.

Don’t Rule Anything Out Just Yet

We think investors must be realistic about the prospects for UK equities this year. From a stock-picking point of view, we look across the whole market spectrum to identify opportunities across the board. While this has become more challenging in the current economic environment, we are cautiously optimistic about the opportunities that may become available.

We’ve seen evidence of a return in confidence to UK stocks. Some equities were previously impacted by the uncertainty surrounding Brexit and a weak sterling last year. With a stronger sterling and a bit more clarity on Brexit, we’ve seen some movement into these more domestic-oriented stocks.

Over the last three years, even businesses in specific sectors such as retail, where UK retail sales have failed to rise for the fifth month in a row,2 still presented good growth opportunities, in our view.

As a result, we wouldn’t rule any sector out based on its classification. Certain retail, leisure and housebuilding companies with good businesses could provide opportunity if we start to see an improving UK outlook.

Our investment process has typically led us to avoid highly-leveraged cyclical companies. These types of businesses tend to have high amounts of debt, which makes it challenging for us to see long-term profitability and cashflow.

As we close another chapter of the Brexit saga, we think markets have come a long way since the knee-jerk market reaction to the 2016 EU referendum. That said, a clearer Brexit timeline will better prime us to identify potential and upcoming opportunities in UK equities.

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1. The FTSE 100 index is a share index of the 100 companies listed on the London Stock Exchange with the highest market capitalization. The FTSE 250 index is a capitalisation-weighted index consisting of the 101st to the 350th largest companies listed on the London Stock Exchange. Indices are unmanaged and one cannot directly invest in an index. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.

2. Office for National Statistics, December 2019.