Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

The UK stock market has certainly not been a favoured investment destination in international circles for some time. The agonies of Brexit negotiations, a lack of the kind of technology behemoths that have driven the US stock market into the stratosphere, and a large economic contraction during the Covid crisis are just a few of the reasons to have stayed away.

In a world filled with investment opportunity elsewhere, it’s no wonder investors have tended to shun the UK. While world stock markets trade close to record highs, the UK languishes by comparison¹. The FTSE 100 Index remains well below its peak of 2020 and only about 10% above where it was just prior to the Brexit referendum in June 2016².

That’s left valuations at levels more suited to sluggish conditions than at the brink of what the IMF expects to be a powerful economic bounce this year amounting to 4.5% of national output (4.3% for advanced economies generally)³.

The UK is lowly rated on the basis of dividend yields, the earnings companies are expected to achieve over the next 12 months (price-to-earnings ratio) and in terms of the value of the assets on their balance sheets (price-to-book ratio). A simple, though not entirely scientific average of these three metrics, suggests the UK market may now trade at a 40% discount to world stock markets and an even steeper discount of 50% compared with the US⁴.

That’s even after many UK dividends were temporarily cut or suspended in 2020. The return of dividends in 2021 and in future years could raise the market’s dividend yield even more, and probably by more than in other countries with histories of lower payout ratios.

So where are we now? As yet, it’s not clear the “Brexit discount” on UK equities has completely unwound, even though a disorderly crash out of the single market was avoided back in January. Clarity on Britain’s trading relationship has undoubtedly improved since the end of last year, but there have been teething problems. Take Germany’s 30% fall in exports to the UK in January, for example⁵.

Positively, trade frictions are likely to ease in time, given that both sides in any agreement have a vested interest to see that they do. Arguably there may be no better time to fine tune customs formalities than when trade volumes are comparatively low. Moreover, the likelihood of new, bilateral arrangements with non-EU countries over time suggests that trade has the capacity to revert to being a positive consideration.

Equally, Britain’s lead in the race to vaccinate – especially important to the UK with its densely populated towns and cities – suggest domestic economic growth could accelerate more potently than in many other countries this year. That’s vital for an economy where consumer spending accounts for around two thirds of the country’s entire output. Currently the UK is behind only the UAE and Israel in terms of the number of vaccine doses already administered per 100 people (40 as at 16 March)⁶.

Meanwhile, the macroeconomic profile of 2021 is shaping up favourably for the UK’s notably economically sensitive stock market. Much of the current talk is about inflation rising above the negligible levels we have become used to, firstly, as a result of rising commodity prices and then as a consequence of increasing consumer demand.

Rising commodity prices should make it easier for the UK’s large mining, energy, consumer staples and utilities sectors to expand their profit margins, after many years of depressed profitability and intense activity centred on cost cutting.

Should consumers, as seems likely, then start to return to their pre-Covid lifestyles later this year, a second type of inflation should start to lift the profits of another large swathe of British companies, such as retailers, leisure providers and financials.

Key to the market’s progress over the next few months will be further signs the domestic and world economies are exiting the Covid recession. A lot depends, of course, on how quickly consumer confidence recovers once current lockdowns end, which remains a big unknown for now. Time though, may be running short for the uncertainty that allows such depressed valuations as the UK is exhibiting now to persist.

Fidelity’s Select 50 list of favourite funds contains two UK funds with contrasting strategies, both aiming for long term capital growth. The first of these, the Fidelity Special Situations Fund, is a long established value oriented fund. It seeks to invest in unfashionable areas of the stock market, but specifically companies undergoing positive change.

Current large holdings include the insurers Aviva and Legal & General which, among other things, stand to benefit from the government’s rebuilding agenda post Covid, owing to their investments in long-dated assets like infrastructure and the green economy.

The Fidelity UK Select Fund approaches the market differently, emphasising particularly businesses that have strong brands and robust balance sheets – “quality growth” companies, in other words. Unilever – attractively valued in relation to its US peers; Burberry, which has pricing power owing to its strong luxury brands; and Rightmove, which dominates its industry group, are among the Fund’s current investments.

Both funds feature in Tom Stevenson’s five fund picks for 2021.

Finally, Easter and the end of the current tax year are now only just over two weeks away, meaning time is running down fast if you’re wishing to make full use of your ISA or SIPP (personal pension) allowances in 2020-21 and haven’t yet done so.

If you are uncertain about your immediate investing plans, remember you can open a Stocks and Shares ISA for this tax year and hold it in cash for the time being. However, miss the 5 April deadline, and this year’s ISA allowance is gone forever – it can’t be carried forward to future years which, we all hope, turn out to be a good deal brighter than the last.

Glossary:

Dividend yield: The dividend per share, divided by the price per share.

Price to book ratio (P/B): A financial ratio used to compare a company's current market price to its book value – the value of a company’s assets.

Price to earnings ratio (P/E): A valuation ratio of a company's current share price compared to its per-share earnings.

Source:

¹ʼ ⁴ MSCI, 26.02.21
² London Stock Exchange, 18.03.21
³ IMF, 26.01.21
⁵ Reuters, 02.03.21
⁶ WHO, 17.03.21

Important information

Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55. The Fidelity UK Select Fund invests in a relatively small number of companies, so may carry more risk than funds that are more diversified. Fidelity Special Situations Fund and Fidelity UK Select Fund may invest in overseas markets, so the value of investments could be affected by changes in currency exchange rates. The funds use financial derivative instruments for investment purposes, which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The funds may also use currency hedging. Currency hedging is used to substantially reduce the risk of losses from unfavourable exchange rate movements on holdings in currencies that differ from the dealing currency. Hedging also has the effect of limiting the potential for currency gains to be made. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.

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