Weekly market recap: changing face of the UK equity market

After weeks of strong performance, the Nasdaq sees its worst day since the March sell-off.

FacebooktwitterlinkedinmailFacebooktwitterlinkedinmail   by Tertius Bonnin, 4th September 2020

A French pensioner in the village of Parcoul-Chenaud, Dordogne got more than he bargained for when he tried to kill a fly. As he swung his electric fly swatter, the spark caused a leaking gas canister in his home to ignite causing an explosion which reportedly destroyed his kitchen and partly damaged the roof of his house. It’s not yet known whether the fly survived or not.

After weeks of strong performance, US investors must have thought their roofs were falling in as the Nasdaq had its worst day since the March sell-off. Asset class returns are below; despite the fall, US equities are still one of the best performing asset classes year to date while UK equities continue to lag.

Figure 1: Asset class total returns, local currency

Source: Bloomberg, EQ Investors

Figure 2: Asset class total returns, GBP currency

Source: Bloomberg, EQ Investors

While equity markets across the developed world have rebounded from their March lows, one region stands out from the rest. The UK has remained one of the worst places to be invested in recent months with the main UK index still down -20% year-to-date. While differences between the UK and the US (up +7.6% year-to-date) can mostly be explained by the significantly higher weighting to the Information Technology sector in the US (which has had a relatively buoyant last few months), other regions with more moderate tech exposure (i.e. Japan and Europe) are still significantly ahead.

So, what’s up with the UK? Well, we think there are a number of factors.

For starters, lets wind back to December when UK equities had a brief period of outperformance following the landslide Conservative election win. The main headwind at this point was the parliamentary Brexit-deadlock where there was no overall majority for any solution. Following the election and the breaking of this deadlock, investor confidence picked up and UK equities saw a re-rating (i.e. they started trading on a higher valuation). So far, so good.

But with the Withdrawal Agreement stage completed and the UK’s exit from the European Union having taken place on 31 January 2020, the two sides set a new deadline of the 31 December 2020 to negotiate a trade deal with the option of extending this midway through the year. Though the UK-EU trade agreement has seen some significant progress, the media frenzy over the Covid outbreak has meant the extension deadline has passed by unmarked. As such, investors are now looking increasingly anxious towards the December deadline where after existing trade arrangements will cease. Should there be a trade agreement, then the angst amongst investors is perhaps unnecessary. However, there are two significant stumbling blocks between now and a deal, so investors are once again preparing for another game of deal or no deal!

Figure 3: Despite a short-lived rally in December, UK equities have underperformed their global peers following the Covid sell-off Figure 4: As hopes of a breakthrough in the deadlocked-Brexit talks rose, so did sentiment towards UK equities relative to the MSCI World
Source: Bloomberg, EQ Investors Source: Bloomberg, EQ Investors

Of course, Brexit isn’t the only factor impacting the UK equity market. In the past, we’ve frequently touched on how international and mature the UK market is and that a large proportion of the underlying revenues from com    panies within the FTSE 100 are derived overseas or are not in sterling. A good example of this is the UK’s (previously) large Energy sector (EN in the chart below) where revenues are generated in US dollars. But with the US dollar under significant pressure, the currency translation effect mean revenues are worth less in sterling terms and therefore the sector has shrunk!

Figure 5: Though sector composition for the FTSE 100 has changed a lot over time, there is a significant lack of exposure to the Information Technology (IT) sector
Source: Bloomberg, EQ Investors

In reality there are numerous other factors also at play than renewed Brexit uncertainty and a weak dollar, such as a fragile global economy. Given their sensitive nature, this will directly impact sectors such as Financials (FN), Energy (EN) and Materials (MT), while the current social distancing rules mean sectors such as Real Estate (RE) and Consumer Discretionary (CD) have been some of the worst hit. It’s not all bad news, however. Investors still point to the fact that the UK is a leader in numerous areas such its Consumer Staples (CS) brands (which include Unilever, Diageo and British American Tobacco), and its Healthcare (HC) brands with AstraZeneca leading the world’s Covid-19 vaccine research in partnership with Oxford University.

STAT OF THE WEEK: 64 million – number of meals eaten as part of the Eat Out to Help Out scheme in the first three weeks (HM Treasury).

DATA CORRECT AS AT: 28/08/2020

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About the author: Tertius Bonnin

Tertius joined EQ in 2016 and is responsible for covering investment ideas within US, Global and Thematic equities. He sits on the fund selection committee and also supports the portfolio managers across a range of other responsibilities.

He passed Level I of the CFA exam in 2018, holds the Investment Management Certificate and has a BA in Business with Finance. He enjoys a variety of sports including skiing, cycling and running – and when not in the office he experiments with Asian cuisine.

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