After more than three years since the 2016 referendum, the UK finally called time on its 47-year membership of the EU on 31 January. And while the break has been a long time coming there is still a need for investors to keep a careful watch on their portfolios.
Since the referendum, UK equities have lagged their international counterparts with investors deterred by the uncertainty over the future EU relationship and its impact on the domestic economy.
As the below chart shows, the FTSE All Share index – which represents at least 98 per cent of the UK market capitalisation – has made a return of 33.51 per cent compared with a gain of 51.03 per cent for the developed markets-focused MSCI World index and a 60.51 per cent for the S&P 500 index, in local currency terms.
Performance of indices since EU referendum
Source: FE Analytics
Now the countdown to Brexit has ended, however, what could investors expect from UK assets?
Matthew Jennings, investment director at Fidelity International, said much of the uncertainty plaguing the UK was due to the failure to articulate a clear vision of how to leave and what comes next.
This was compounded, he said, by the hard-left opposition Labour party under Jeremy Corbyn promising tax hikes and nationalisation.
“Such a cocktail of political uncertainty and seemingly anti-business sentiment left asset allocators, corporations and, to some extent, consumers with little incentive to invest in the UK economy or in UK stocks,” he said.
Karen Ward – JP Morgan Asset Management’s chief market strategist for Europe, the Middle East & Africa – said the ‘Corbyn risk’ has now been removed and the Conservative party’s landslide victory in the general election should ensure five years of political stability.
“A new election will not take place until 2024, leaving the Labour party plenty of time to reflect, select a new leadership team, and decide whether it wants to reposition itself on the political spectrum,” she said.
With the two of the biggest sources of uncertainty being alleviated, commentators said UK stocks could start to see greater interest from international investors, particularly at current valuations.
Fidelity International’s Jennings said that after years of underperformance and with other markets trading at “lofty valuations”, UK stocks now appear cheap on a relative basis.
“While the UK typically trades at a discount to the high growth US market, the differential today is historically unusual,” Jennings explained. “A more benign macroeconomic backdrop, as well as a changing political narrative, in both the UK and US could drive a narrowing of the valuation discount.”
The domestic market also looks attractive from a yield perspective as the post-financial crisis era of low interest rates shows few signs of coming to an end.
“Globally, investors are desperately searching for yield as central bank interventions have pushed down the income on offer in bond markets and forced income investors to turn to equity markets,” said JP Morgan’s Ward.
“With an overall dividend yield of 4.1 per cent, the UK equity market is one of the highest dividend payers in the developed world.
“Those who suspect, like us, that concessions will ultimately be made in the Brexit negotiations might also be tempted by the relatively attractive valuations of the UK market and the potential for currency uplift further down the line.”
It’s not just UK stocks that might benefit, with sterling also likely to benefit from a more stable political environment.
As the chart below shows, the pound has fallen by 10.92 per cent since the EU referendum.
Performance of sterling in US dollar terms since EU referendum
Source: FE Analytics
“Sterling has been the most obvious barometer of investors’ sentiment about Brexit,” said Jonas Goltermann, senior market economist at consultancy Capital Economics. “The currency’s fortunes over recent years have closely tracked the perceived probability of a ‘no deal’ exit.
“As the risk of that outcome fell over the second half of 2019, the pound has already rebounded a bit. But on a trade-weighted basis, it remains about 7 per cent weaker than before the referendum, and 14 per cent weaker than in mid-2015.”
While a stronger pound would be negative for some sterling-based income-payers, it would aid more domestic-focused stocks more generally although it might take some more time – and a successful trade deal – before small-caps start performing well.
The outlook for UK property is mixed, however.
James Thornton, chief executive of Mayfair Capital, said greater certainty over Brexit should help drive higher GDP growth, while continued high employment and greater public spending – as proposed by the Conservatives during and following the election – should be supportive of property.
“We do not believe a higher sterling will deter foreign investors who have been more concerned by the political uncertainty in the UK,” he said. “Ultimately, property returns are correlated with economic growth.”
However, Calum Bruce, investment manager of Ediston Property Investment Company, warned that leaving the EU remains one of the “biggest unknowns” for markets currently.
“The market continues to experience lower transaction volumes,” he said. “Political uncertainty has acted as a brake on investment activity, as investors seek clarity on the key issues before making investment decisions. This inertia is likely to persist until the political landscape alters.”
Nevertheless, said Bruce, the property investment market is not dead with deals continuing to be made despite uncertainty.
“Assets that are well-located, trade well and are let off affordable rents are more desirable,” he added.
While a more stable political environment is to be welcomed, the road to Brexit still has some way to go with a new trade deal with the 27-member EU bloc due to be negotiated in the coming year, a process that has taken years with other non-EU members such as Canada.
Colin Morton (pictured), lead manager of the £865.6m Franklin UK Equity Income fund, said while it was positive that Brexit was finally being put to bed, investor expectations needed to be pared back somewhat.
“We think investors must be realistic about the prospects for UK equities this year,” he said. “From a stockpicking 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.”
He added: “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.”