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Time to buy UK domestic stocks on crisis lows?

UK domestic stocks are trading at their lowest rating since the financial crisis, offering compelling value to some fund managers.

 
Time to buy UK domestic stocks on crisis lows?
 

Contrarian and value-focused fund managers are excited about the rock-bottom valuations of UK domestic stocks, which are trading at their lowest levels since the financial crisis.

UK domestic stocks are trading at around a 25% discount to the wider UK market, close to financial crisis levels when they traded at a 30% discount.

Many investors have shunned them in favour of overseas stocks and funds, or UK-listed stocks which derive more of their revenues from overseas, amid fears over Brexit and its impact on the UK economy.

Fund sales figures from fund manager trade body the Investment Association have shown UK funds consistently suffering outflows, despite record-breaking sales elsewhere.

Globally, a third of fund managers are 'underweight' UK stocks, their most bearish stance since the financial crisis.

'It is hard for me to think of a less popular area anywhere in the investment universe at present than UK domestic stocks,' said Steve Davies, manager of the Jupiter UK Growth fund and its investment trust namesake. 

'Investment sentiment towards the UK is now as bad as it was in 2008 when much of the UK banking system was on the verge of collapse.

'This appeals to my contrarian instincts and, in some ways, reminds me of how low sentiment towards emerging markets had sunk a couple of years ago. Emerging markets have delivered very strong returns since then, illustrating that a low point in sentiment can sometimes be a great period to invest in markets.'

Financial crisis lows

Martin Walker, manager of the Invesco Perpetual UK Focus and UK Growth funds, likewise highlighted the strength of investor bearishness over domestic UK stocks.

'Valuations for UK domestics have de-rated to global financial crisis lows, supporting a view that even a modest improvement in the outlook for the UK, sterling or the consumer may be enough to prompt some better performance.'

That echoes the view of the UK's most famous fund manager, Neil Woodford, who earlier this year overhauled his flagship Woodford Equity Income fund, buying a host of cyclical, domestic UK stocks, arguing the UK economy would perform better than the 'bearish consensus'.

For investors in funds with a UK domestic focus, any change in sentiment can't come too soon. The once Citywire AAA-rated Steve Davies has seen his previously strong track record come unstuck as the fallout from the Brexit vote punished his portfolio: over the last three years, his fund sits bottom of the Investment Association's UK All Companies sector, having returned just 10%.

Woodford's shift into UK cyclicals has meanwhile done little so far to rescue performance in what has been a difficult year. His flagship fund sits just one place off the bottom of the UK Equity Income sector over 12 months, having returned 4.2%.

Walker has fared better over the last year, with his UK Focus and UK growth funds sitting in the top half of the UK All Companies sector over that period, powered by BP (BP) and Shell (RDSb) as the oil price has recovered.

But it is in his UK retail holdings like Sainsbury's (SBRY) and Marks and Spencer (MKS) that he sees the most value, with the shares suffering from a Brexit-induced pessimism over the UK economy.

'Current thinking about Brexit seems a bit "post-truth" to me, a bearish outlook which appears to be more a belief of the heart than the head,' he said.

'While the process will inevitably continue to generate headlines about the two sides' positions and the economic impact of a good deal or no deal, I remain constructive about the long-term outcome. Even now, at the height of uncertainty the economy is delivering modest growth.'

Catalysts for change

He pointed to 'substantial upside' for the pound from less-bad-than-feared progress from the UK economy, which could see the tables turned on the current outperformance of international stocks and weakness among domestic shares. 'This is just one scenario I am considering in the construction of my portfolios and forms one part of my investment case for UK retailers.

Walker argued that shares in retailers had also come under disproportionate pressure from fears over the shift to online consumption. 'The likes of Sainsbury's and Marks and Spencer are among the most unloved in the sector on very low valuations; I believe both companies provide value investors plenty of optionality on even a marginal improvement in trading momentum.'

Davies doesn't share this enthusiasm about supermarkets, holding none in his fund. He warned that while UK domestic stocks as a whole were trading at low valuations 'a number of domestic companies are facing structural challenges as well as cyclical ones, be it from low-cost discounters in the case of food retailers or new online competition in a host of sectors'.

He highlighted some of his holdings such as WH Smith (SMWH), Howden Joinery (HWDN), Taylor Wimpey (TW) and ITV (ITV) as examples of 'well-placed businesses [that] have seen their share prices dragged down by the general apathy towards the UK'.

Davies pointed to three potential catalysts for a reappraisal of UK domestic stocks: progress in Brexit discussions, a pick-up in mergers and acquisition activity and improvement in UK economic data.

'Nobody would deny that the UK faces some major challenges in the coming years, but the question for investors is: how much bad news has already been priced into the market? My view is that any outcome better than a substantial economic slowdown on a par with the global financial crisis should mean that there is a currently unrecognised value in UK domestic stocks.'

6 comments so far. Why not have your say?

Micawber

Nov 09, 2017 at 17:40

I don't think that 'no deal' and 'Corbyn-McDonnell government" are fully priced in, yet......

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jvl

Nov 09, 2017 at 18:46

I wish for 'no deal', it being the freedom to trade with whom we wish, spend our own money, decide our own rules and tax levels... as opposed to the overrated strangulation of the EU. I wouldn't choose the self-strangulation option for £10 billion, let alone £50 billion.

But it won't happen. May's hopeless. I predict that not only will she give in and give the EU more than £50 billion, she'll also agree to tie our own hands with respect to 'unfair' competition re regulations and taxes. A terrible deal - tying ourselves to the legs of blind sloths in a world of growing hungry tigers.

I'm more confident that a Corbyn McDonnell government will not happen. Support has peaked for them at this level. The current government can't get much worse and yet Labour aren't doing better in the polls. No more buyers.

Not that that's much of a comfort seeing this horrible left-leaning, big-state, mess of a government...

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Hank Elvis Dobbs (texan)

Nov 09, 2017 at 18:47

With the price of some domestic stocks in mind.Tristian the guy that empties my bins reckons that "according to persons familiar with the situation" the people smugglers are leaving Syria "In droves" looking to set up somewhere near Dover, in anticipation, of no deal...

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Micawber

Nov 10, 2017 at 07:01

I hope for all our sakes that your dreams come true, jvl.

But I'm not putting my money on it.

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Hotrod

Nov 10, 2017 at 10:04

Domestic stocks, i.e. (food, clothes, furniture, haberdashery electrical etc.) operate in a saturated market; which means thin margins forever.

Fund managers are attracted to them because of the ease with which they can buy/sell large tranches of shares and a steady stream of dividends.

As previously stated, political considerations override these criteria.

My aim is to do better than mediocre therefore none of the stocks mentioned appear in my portfolio.

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Mike R

Nov 11, 2017 at 09:39

JV I see at the moment very little difference between the two Government options you list. How has Brexit and before been handled by the present and resigned incumbents . What has already happened does not bode well for the future and shows already in my view politics for the sake of the Conservatives, self interest, incompetence , inability and a task beyond their capability. Oh and i nearly forgot -- a lack of truth and a deliberate concealment of Information from the Total electorate . I do not rate the present Cabinet from PM down .

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