The referendum result has created great political and economic uncertainty for the UK. The outcome of the negotiations with the European Union will have a large effect on the future of the UK, the value of the pound and the relative performance of different sectors.
Domestic vs international exposure, large vs small?
- The large cap FTSE100 gets most of its revenues from abroad whereas the mid cap FTSE250 has a larger exposure to the domestic UK economy. Therefore a fall in the pound should favour internationally exposed large cap stocks whereas a rise in the pound should favour smaller more domestically focused stocks.
- After many years of outperformance mid-cap stocks look somewhat expensive relative to large cap stocks.
- Large cap earnings are also coming from a lower base, suggesting more potential upside than already elevated FTSE250 earnings expectations.
Guide to the Markets - UK, page 45
Attractive income and commodity exposure
- In a world where income is still hard to come by, UK equities offer a very attractive dividend yield relative to other equity markets.
- Earnings expectations for UK-listed companies collapsed for five years, driven mainly by the fall in commodity prices. As commodity prices rebound, earnings expectations are improving.
- UK equities stand to benefit more than most other developed markets from any further improvement in commodity prices.
Guide to the Markets - UK, page 44
UK valuations are relatively attractive
- UK equities are neither cheap nor expensive relative to their historical average price-to-earnings (P/E) ratio, but relative to government bonds the dividend yield available on UK equities still looks very attractive.
- UK earnings have plenty of room for recovery after their poor performance in recent years. As a result, the cyclically-adjusted P/E, which takes into account the position in the earnings cycle, leaves UK equities looking very cheap relative to their long-term average.
Guide to the Markets - UK, page 46
- Weaker sterling, combined with undemanding cyclically adjusted valuations and a high dividend yield, could provide support for UK equities.
- Large cap equities are less exposed to potential domestic economic weakness than mid and small cap companies.
- That said, the uncertainty created by the Brexit negotiations argues for taking relatively small active sector and size bets relative to the benchmark.
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