With Brexit negotiations looking increasingly fraught, the gloom surrounding the UK stock market could be sowing the seeds of a strong rebound next year, according to Citywire A-rated fund manager Alex Wright.
Wright, who runs the £3 billion Fidelity Special Situations fund, and similar Fidelity Special Values (FSV) investment trust, said the ‘unrelenting negativity’ investors have for UK equities is ‘making me feel more and more positive on their prospects for 2019’.
‘It might be counter-intuitive to think that the UK market could be among the top performers globally in the year that we leave the EU – if indeed we do,’ he said.
‘But markets have a way of confounding expectations and surprising consensus.’
While Wright does not hold a view on whether Brexit will be ‘hard’ or ‘soft’ come 29 March, he believes clarification on the relationship is what matters as investors ‘hate uncertainty’.
There has been ‘little incentive’ to invest in UK shares while the government hammers out a deal with the EU - there have been £3.1 billion of outflows from all-cap UK equity funds this year - and Wright said that anecdotally, US clients were even refusing to buy global oil companies as they are listed in the UK.
‘Closer to home, I can’t remember the last time I met a UK-based client who was increasing their UK exposure,’ he said.
Discounted valuations have not been enough to draw investors into UK equities but Wright (pictured) said when investing in unloved companies ‘you shouldn’t necessarily wait for good news to become obvious before investing’.
‘By investing when all the bad news is ‘in the price’ and no good news is expected at all, you put the odds in your favour,’ he said. ‘I think this is a situation we are in in the UK at the moment.’
He added that the UK market was currently trading at 12 times earnings compared to 14 times earnings in the rest of Europe and 17 times earnings in the US.
But he said that these headline ratings concealed starker differences in the ratings between specific UK stocks and comparable companies in mainland Europe. He gave the example of four of the stocks in his fund:
'Lloyds (LLOY) languishes on a seven price-earnings (PE) multiple, while only 250 miles away, Belgian bank KBC (KBC.BR) enjoys a 40% premium, on a rating of 10 times, despite having very similar characteristics and long-term growth prospects.
'It is fair to expect some discount for UK domestic stocks compared to US and European counterparts, but current discounts seem excessive, and apply to international-facing stocks too.'
But Wright cautioned that ‘not all UK stocks are equally attractive’.
'I am happy buying unloved domestic stocks if I can see a balance sheet that can withstand a period of economic weakness, and valuation that gives me some margin of safety,' he said.
'But Special Situations has around 32% of revenues generated in the UK compared to 30% for the FTSE All Share, so by no means am I expressing a view on a particular Brexit outcome in the fund positioning.'
Fidelity Special Situations has returned 37% over five years to the end of October, versus the average of 26.8% for funds in Citywire's UK All Companies sector. Over three years it is up 26.1% versus an average 19%.