Ian Lance

Ian Lance

Portfolio manager

Phoenix from the Ashes

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There have been plenty of reasons for investors not to allocate money to UK equities in recent years or to actively allocate away and towards the US. These have included the uncertainty created by Brexit, the government’s mishandling of the Covid-19 crisis as well as the fact that the index was considered to be heavy in sectors that no one wanted to own (energy, materials, financials) and light in the sector that everyone loved (technology). Conversely, the US had large exposure to all the stocks that investors wanted, and hence it seemed obvious to allocate out of the UK and into the US (and many investors did!). The net result of this, as the chart below shows, is that the UK is now the second most hated asset class after the energy sector (although there is an element of double counting here as many people will hate UK equities because of the energy and banks component which is the fourth most hated area!).

Source:  BofA Global Fund Manager Survey.

If one accepts the premise that the greatest gains are to be made from buying the most out of favour asset classes, then maybe now is the time to start allocating back towards UK equities. As the chart below shows, the starting valuation certainly seems to suggest an increased allocation is worth considering as the UK is trading at a 50-year low valuation against the US. Having traded at an average discount to the MSCI World Index of 17% throughout that period, it is now standing at an incredible discount of 45%.

Source:  Morgan Stanley, 30th October 2020.

It’s also worth noting that much of the performance of the US index has been down to the FANMAG stocks[1]. Since the market low on 23rd March, the S&P 500 has rallied 58%[2] and the FANMAG (just six stocks:  Facebook, Amazon, NVIDIA, Microsoft, Apple, and Google) made up 29% of that move, with Apple alone contributing 10% of the index move. Since the beginning of 2016, the S&P 500 has returned 73%[3] with the FANMAG contributing 42% of returns.

It’s also worth noting that the majority of these returns have come from a re-rating as the chart below shows. The prime example of this is Apple where the shares have risen fourfold in the last five years whilst net income has increased by a mere 7%. If these shares begin to de-rate, the downside could be considerable and if the process noted above goes in to reverse it will drag the US index down with it.

Source:  Morgan Stanley, 30th October 2020.

Meanwhile, anyone who believes that we are past the trough of the economic cycle and that 2021 is likely to see a recovery from a low point will presumably want exposure to sectors likely to benefit such as energy, materials, financials and industrials which happen to be rather well represented in the UK index. Equally, anyone wanting to hedge their equity exposure against a central bank inspired by an increase in inflation would need exposure to these same sectors which have historically performed well as inflation has increased. Who knows, maybe this time next year the UK, energy and banks will be the most popular sectors and US will be the least. Stranger things have happened!

[1] FANMAG: Facebook, Amazon, NVIDIA, Microsoft, Apple, Google.

[2] 23rd March 2020 to 12th November 2020 price change in index.

[3] 31st December 2015 to 12th November 2020 price change in index.

Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested. The names shown above are for illustrative purposes only and is not intended to be, and should not be interpreted as, recommendations or advice.

The statements and opinions expressed in this article are those of the author as of the date of publication, and do not necessarily represent the view of RWC Partners Limited. Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested. This article does not constitute investment advice and the information shown above is for illustrative purposes only and should not be construed as a recommendation or advice to buy or sell any security. No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment.

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