Why the UK stock market is currently on the defensive

All of the headlines regarding the UK stock market may well be dominated, in the short term at least, by the result of the Meaningful Vote in Parliament on Prime Minister Theresa May’s proposed Brexit deal on 11 December.

This column will try not to get involved in the perceived rights or wrongs of the deal, because it has enough on its plate keeping in touch with markets, let alone politics, and nor does it wish to be seen to be taking a partisan stance of any kind.

But what does seem clear from price action in the UK’s stock, bond and currency markets is that no-one seems to fancy ‘no deal’ as the outcome of the negotiations with the EU and the upcoming Parliamentary debate (even if economist Roger Bootle and FTSE 250 pubs group Chief Executive Tim Martin regularly and passionately argue that ‘no deal’ and the adoption of World Trade Organisation rules would be no obstacle to a prosperous future).

Whether a deal of some kind or no deal of any kind becomes the outcome is still unclear, as are the implications for the UK’s economy and its financial markets.

Throw in wider concerns over trade and tariffs and a global trend toward tighter monetary policy, in the form of higher interest rates and less Quantitative Easing (or even its withdrawal), and advisers and clients and fund managers seem to be responding in a tried-and-tested way when it comes to their UK equity exposure – they are taking a defensive posture in a bid to weather any political (or other) storms.

Change in tone

They are doing so in two ways.

This can be seen very clearly by looking at which of the 39 industrial groupings have done best – and worst – on a quarterly basis since the start of 2018.

Best and worst 10 performing sectors within the FTSE All-Share, by quarter, in 2018

Source: Refinitiv data. * Fourth quarter covers period up to 30 November.

  • The first is a switch away from cyclical sectors like Autos & Parts (which also received a boost from Melrose’s bid for GKN), Industrials, Forestry, Media and Chemicals towards more traditionally stodgy areas such as telecoms, food stocks, utilities and pharmaceuticals.
  • The second is a switch toward value. Technology Hardware has dropped out of the quarterly list of top ten performers and previously downtrodden laggards have stepped up, notably Fixed-Line Telecoms (a sector where many a value manager has been talking up BT’s potential); utilities, which analysts argue look cheap relative to the asset bases; and even the Banks, where low multiples of book value hint that a lot of bad news may be in the price (even if some would argue deservedly so).

Shift in stance

Whether this apparent dash for safety, either in the form of defensives or stocks where lowly valuations may provide some downside protection, is the result of global fears over say US Federal Reserve policy, trade wars or more domestic matters such as Brexit is hard to say.

But the fourth quarter’s stock market action does again differ quite markedly from what we have seen since the EU referendum on 23 June 2016.

Since then, trading has generally been dominated by weakness in the pound and therefore strength in overseas earners and exporters, and especially those stocks who fit these descriptions and have exposure to the US economy and do little business here at home. By contrast, sectors with substantial exposure to the UK, such as retailers, construction and the utilities have lagged – with utilities particularly poor thanks to the threat, perceived or real, posed by the prospect of a Labour Government under Jeremy Corbyn should the Tory Government tear itself to bits.

Best and worst 10 performing sectors within the FTSE All-Share since 2016’s EU referendum.

Source: Refinitiv data. Covers period from 23 June 2016 to 30 November 2018.

The possibility of some sort of Brexit deal between the UK and EU means this trade of ‘pound down, exporters up’ has lost some of its lustre – but if the May deal is rejected and her Government falls then it would be logical to expect sterling to slip and fund managers to investigate this strategy once more.

The mathematics of MPs votes suggest this could well happen. But if the Brexit deal is approved, and ‘no deal’ avoided, perhaps sterling and those long-neglected domestic sectors could return to favour. Given their underperformance and notable unpopularity that may be where the value lies in a UK market that itself looks cheap relative to its global peers, on just 11.6 times earnings and with a 4.8% dividend yield for 2019.

Why could this be interesting? As it often does, this column will let master investor Warren Buffett have the last word.

“The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices that it produces. It’s optimism that is the enemy of the rational buyer.”

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.