Philippa Aylmer writes that with UK assets looking attractive relative to the rest of the world and the end of the Omicron wave in sight, it might be easy to dismiss ‘partygate’. However, Stuart Clark, portfolio manager at Quilter Investors warns investors to expect increased volatility in 2022.
“Should we see a leadership challenge or a general election then markets will naturally react to these events. And while the overall market impact may be minimal, investors should not rest on their laurels,” says Clark.
“The problem the UK has for investors is that while it looks cheap compared to the rest of the world, it is so for good reason. Political risk was already a threat for investors as a result of the fallout from the Brexit deal. Foreign investment has been lacking and should we see more uncertainty in Westminster then we should expect the UK to remain undervalued for some time to come yet.”
A recent Hargreaves Lansdowne survey found that there has been a 2 per cent drop in confidence in UK economic growth amongst investors although since November investor confidence in UK assets has actually increased by 4 per cent.
Daniel Casali, Chief Investment Strategist at Tilney Smith & Williamson, says that “much of the concerns about long-lasting damage to the UK economy from covid appears to be misplaced. Employment and GDP are now higher than the pre-pandemic February 2020 level.” He also points out that GDP recovered all the lost output over the past two years far quicker than the five years it took after the previous recession during the Global Financial Crisis in 2008.
“Nevertheless, UK relative equity market valuations are still below the pre-pandemic level,” Casalie says. The MSCI UK 12-month forward PE currently stands at 12.3x, or 7 per cent below the level in mid-February 2020. “On balance, less risk of lockdowns and still-cheap UK equity valuations offers an opportunity for investors. This probably helps to explain why the UK has outperformed global peers so far this year,” he adds.
Quilter’s Clark sees Europe as a more attractive region, as it has the same undervalued qualities, relative to the rest of the world, without so much political uncertainty.
He believes that investors today have to assess whether there is the potential for a short-term bounce (buy the dip mentality is maintained), more to come before resuming an upward trend (mid-cycle pause before resuming an upward trajectory) or “even that there is a more significant correction to come – double dip recession, the new cycle ends as abruptly as it started or indeed, we didn’t enter a new business cycle at all and we are at the end of an extended cycle.”
In terms of portfolio positioning, Quilter’s WealthSelect managers had been reducing risk through the latter part of last year says Clark, “to be sitting near the bottom of our agreed limits by reducing equity and government bonds in favour of alternative holdings that are less reliant on market direction to generate returns.”
Clark explains that client portfolios have been running with higher cash weights than perhaps others may consider typical. This is because “we believe the risk budget has been better spent elsewhere ie barbelling equity and cash with higher alternatives exposure and more moderate levels of bond holdings.” However, he questions whether the back up in government bond yields means that the relative attractiveness of bonds versus equity/cash is less clear cut today and therefore might justify a reallocation between the bond/equity portion to maintain the overall risk budget but with a lower allocation to equity markets.
Ultimately, states Clark: “Volatility will come and can be unsettling but keeping your eyes on the long-term will allow you to view that volatility as an opportunity.”