With the Brexit trade deal finally finalized and the rapid roll-out of the COVID-19 vaccine, UK value stocks could become “the trade of the decade”.
That is the view of Research Affiliates founder Rob Arnott, who said the end of the COVID-19 threat was now in sight in the UK, potentially creating a ‘real tailwind’ for the economy and the stock market.
A combination of factors, including uncertainty surrounding Brexit and the devastating impact of the pandemic, pushed UK value stocks to “unbelievably low levels,” Arnott said, and they remain “remarkably low”.
The country has emerged as an early leader in the vaccine rollout, with 17.9 million people – about a third of the population – already receiving at least one dose. The government hopes to vaccinate every adult by the end of July. It has also plotted its roadmap not to lock, aiming to lift all restrictions by June 21
The post-Brexit trade deal agreed in December has also allayed many concerns, although some areas, such as financial services, have not yet been resolved.
“All over the world, value is traded at extremely high discounts in relation to growth. However we measure the valuation, the value-to-growth rebates are greater than 95% of the country or region’s history, except in Australia, ”said analysts led by Arnott.
“The tailwind of Brexit and the rapid vaccination against COVID make the UK’s low valuation particularly attractive,” she added.
Read: If you think it’s time to switch to value stocks, here are Wall Street favorites
In January 2016, Research Affiliates named emerging market (EM) value stocks as the trade of the decade. The analysts said they still liked emerging value stocks, but that the UK stock market, especially value stocks, was now even cheaper.
Source: Research Affiliates using data from CRSP / Compustat and Worldscope / Datastream
“UK equities are distinguished by offering one of the most attractive risk-return tradeoffs, priced to yield a notch higher than emerging market equities with significantly lower volatility,” Arnott said. Both UK and EM value stocks could turn out to be the trading of the decade, he added.
The UK has one of the highest COVID-19 death tolls – 121,305, according to government data – behind only the US, Brazil, Mexico and India. The economic impact of the pandemic on the UK has also been severe, with most of the country currently in its third lockdown.
Gross domestic product contracted by 9.9% last year, the worst annual decline since the Great Prince of 1709. Along with the pandemic, negotiations for a post-Brexit trade deal were running on the wire, with an agreement finally 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 said.
Corporate earnings in the UK are down 88% in 2020, much steeper than the 17% decline in the US and the 50% decline 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.
As a result of all this, UK stocks are currently trading in the cheapest quintile of their historical standards – based on both price accounting and price five year average cash flow ratios.
Read: Mining stocks have risen sharply in a struggling UK market
In contrast, Arnott said the US stock market was only more expensive than its current valuation, based on price book value, one-sixth the time in the past 60 years, and only 8% of the time based on price. average cash flow ratio over five years.
Inexpensive valuations could either mean buying opportunities or a trap in which British companies continue to decline, Arnott noted, before concluding it was the former in this case.
“Neither Brexit nor the COVID-19 pandemic is likely to have nearly as much impact in 2026 as in 2020-21. Therefore, the market shocks caused by these events are now an opportunity, ”he said.