Ideas Farm: UK flicks the Vs

Prospects suddenly seem to be looking brighter for UK markets. Since bottoming out at the end of October, the much maligned FTSE 100 index is up 14 per cent while the 250 has gained 13.5 per cent. The principal reasons for the change of heart can be summed up with three Vs, and there could also be a fourth V on the way soon.

Firstly, V is for vaccines. Positive late-stage vaccine trial results from both Pfizer and Moderna have given all markets, but especially the UK, a shot in the arm this month. As well as these trials, there are many other vaccine candidates being tested, which could have even better results. While there is much work to be done before an effective Covid-19 vaccination programme is rolled out, there is plenty of effort being made to try to ensure the light at the end of the tunnel becomes bright blue sky.

The second V is for V-shaped recovery. There’s justified scepticism about the potential for a strong economic bounce back. However, the very particular nature of the massive downturn in GDP in 2020 means it should not be ruled out. And the prospects of a vaccine-led return to normality makes the scenario much easier to imagine. 

This is especially true for the UK because the economy is so weighted towards consumption. Reliance on debt-fuelled consumers may not be such a great thing always. However, this facet of UK GDP does mean there is the potential for pent-up consumer demand to ignite a strong and self-sustaining recovery when coupled with fiscal stimulus and restocking. The remarkable strength of the UK housing market suggests such a narrative is not utterly far-fetched. Indeed, while it often sounds smart to play the pessimist at times such as this, it is often far more profitable to act the optimist. 

The third V benefiting UK stocks stands for 'value'. The UK market has done badly during the crisis because it is dominated by many large, mature and uninspiring cyclical companies. These companies are not going to suddenly transform into wonderful long-term investments, but their prospects certainly look a lot more enticing should our collective lockdown misery be about to finally end. In the meantime, cyclical companies’ profits and valuations have become extremely depressed, which ironically would suggest the UK market has more to gain from the recent good news than markets that are home to better companies.

The fun for UK investors may not be over with these three V’s. There is one more potential V waiting in the wings. That V stands for (admittedly this is a bit contrived) a victorious outcome to Brexit trade negotiations. Victory in such haggling matches is usually based on finding a mutually acceptable compromise rather than establishing a winner and a loser. Rumours that this fourth positive development for UK stocks may soon be in place means the recent run may find new legs. 

In all, while UK stocks have had a dire 2020, there is still hope for Christmas. The positive factors currently at play may provide the good set-up for a so-called Santa Claus rally. Should that prove the case, UK smaller companies may well be big beneficiaries and this week we are publishing our list of the favourite UK small caps of the top fund managers we follow.