Investors appear to be looking at Britain in a state of utter confusion. They are voting with their feet, selling up and moving money to overseas markets. According to data from Morningstar, in August a net £2.3bn was pulled from UK-focused funds. This marked the fourth month of net outflows in a row.
There are some clear culprits for the exodus. As highlighted in last week’s Ideas Farm column, British blue-chips do a poor job in capturing the investment zeitgeists of tech and growth. There is also the question of how the UK finances stimulus during and after lockdown. And the UK’s response to Covid-19 has looked haphazard at times.
Normally these issues may not cause money to take flight in such volume. However, they are occurring against the backdrop of Brexit negotiations. This week, the haggling has entered a pivotal phase with an end-of-year deadline closing in fast.
Putting partisan politics aside, leaving the EU represents a big gamble. There are credible arguments that the UK’s departure could turn out really well or really badly. For investors, the job is to assign probabilities to where on the good-bad spectrum the UK will end up. But with so much to disentangle and reassemble, and so many moving parts, any hope of precision is futile.
This scope for uncertainty means it is easy to get overly pessimistic when sentiment is bad and crunch time approaches.
As well as the heavy selling of UK-focused funds, valuations point to major pessimism. Based on the cyclically adjusted price/earnings ratio (CAPE) compiled by investment firm Star Capital, at 12.6 the UK has the sixth lowest CAPE of 40 countries monitored. The CAPE ratio values markets against average earnings over 10 years to smooth the ups and downs of economic cycles.
For contrarians, this suggests an opportunity for profit may exist from this week’s Brexit negotiations, which are designed to propel talks into the final-phase “tunnel”, and related events over the coming months. The dour mood suggests potential upside from positively perceived developments could be substantially greater than downside from an outcome that is regarded as bad. True, longer-term concerns about the UK market and economy will not magically disappear, but any short-term relief rally could be pleasant.
In terms of potential beneficiaries, this week’s Ideas Farm takes a look at the favourite London-listed shares of a selection of top fund managers. The tips section this week, meanwhile, looks at two unloved UK stocks that could benefit from improving sentiment. One of these, Babcock (BAB), we’ve concluded should be avoided. But in the case of the other, Virgin Money (VMUK), we feel it may be having its resilience and recovery potential underestimated – unlikely as this may seem at first sight.
Also of note is that Babcock appears on our list of most shorted shares and broker downgrades, while Virgin Money has recently been found on the list of broker upgrades. As always, our view may not align with the future course of share prices, and readers that find the cases we advance interesting are encouraged to do their own research.
