With the Brexit trade deal finally closed and the launch of the COVID-19 vaccine continuing at a rapid pace, UK value stocks could be ‘the trade of the decade’.
That’s the view of Research Affiliates founder Rob Arnott, who said that an end to the COVID-19 threat was now in sight in the UK, potentially creating a ‘real tailwind’ for its economy and stock market. .
A combination of factors, including the uncertainty surrounding Brexit and the devastating impact of the pandemic, drove UK equity stocks to “incredibly cheap levels” in late 2020, Arnott said, and they remain “remarkably low” .
The country has become an early leader in the deployment of vaccination, with 17.9 million people, about a third of the population, already receiving at least one dose. The government hopes to vaccinate all adults by the end of July. It has also established its roadmap to get out of the lockdown, aiming to lift all restrictions by June 21.
The post-Brexit trade deal, agreed in December, has also removed many concerns, although some areas, such as financial services, remain unresolved.
“All over the world, the stock is trading at deep discounts relative to growth. No matter how we measure valuation, value-growth discounts are wider than 95% of the history of the respective country or region, except Australia, ”said analysts led by Arnott.
“The Brexit tailwinds and rapid COVID vaccination make the UK’s low valuation especially attractive,” they added.
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In January 2016, Research Affiliates named Emerging Markets (EM) value stocks the trade of the decade. Analysts said they still liked emerging market value stocks, but the UK stock market, and value stocks in particular, were now even cheaper.
Source: Research Affiliates with data from CRSP / Compustat and Worldscope / Datastream
“UK stocks stand out as offering one of the most attractive risk-return tradeoffs, priced higher than emerging market stocks with significantly lower volatility,” Arnott said. “Both UK and emerging market value stocks may turn out to be the deals of the decade,” he added.
The UK has one of the highest death toll from COVID-19 (121,305, according to government data) only behind the US, Brazil, Mexico and India. The economic impact the pandemic has had on the UK has also been severe, with most of the country currently in its third shutdown.
Gross domestic product contracted 9.9% last year, the worst annual decline since the “Great Frost of 1709.” Along with the pandemic, negotiations on a post-Brexit trade deal were shortened to the limit, with an agreement finally being reached on Christmas Eve. More broadly, Brexit has had an impact on UK valuations since the country voted to leave the EU in June 2016, Research Affiliates noted.
UK corporate profits fell 88% in 2020, much steeper than the 17% drop in the US and the 50% drop in Europe. When it comes to stock market performance, UK value stocks fell 15% last year, while growth stocks were up 4%, Research Affiliates said, citing data from Russell.
The upshot of all this is that UK stocks are currently trading in the cheapest quintile of their historical norms, based on average book price and five-year price cash flow rates.
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By contrast, Arnott said the U.S. stock market has only been more expensive than its current valuation, based on price-to-book ratio, one-sixth of the time in the last 60 years, and only 8% of the time according to the price. Five-year average cash flow ratio.
Cheap valuations can spell buy opportunities or a value trap that UK companies keep falling into, Arnott noted, before concluding that it came first in this case.
“Neither Brexit nor the COVID-19 pandemic is likely to have as much impact in 2026 as in 2020-21. Therefore, the market shocks induced by these events represent opportunities now, ”he said.