Brexit deal: a turning point for UK equities despite lockdown three?

Investment company managers comment on the Brexit deal and its potential impact on the UK stock market.

Brexit Compressed

The Christmas Eve announcement of a UK-EU trade deal promised an end to four and a half years of uncertainty and speculation. Whilst there are areas of the relationship still to be finalised, it has brought some much-needed clarity to UK businesses. Could this be the turning point for UK equities, even as the country has entered its third lockdown?

The Association of Investment Companies (AIC) has asked the managers of UK-focused investment companies about which sectors will be the winners and losers from the deal, how the latest lockdown will affect businesses compared to previous lockdowns and the longer-term outlook for the UK in light of the Brexit trade deal.

Stronger sterling

Guy Anderson, Portfolio Manager of The Mercantile Investment Trust, said: “While portfolio companies have had a number of years to prepare for the various potential outcomes of Brexit negotiations, the trade deal, which allows a continuation of tariff and quota-free trade in goods between the UK and EU, will be welcomed by many. In particular, companies that source goods or material inputs from the EU should benefit from low-friction trade and stronger sterling. For example, convenience food producer Greencore estimates that up to one third of its raw materials are sourced from the EU. While the company had done extensive contingency planning, the trade deal will have been well-received.”

Opportunities in sustainability and financial services

Margaret Lawson, Lead Manager of SVM UK Emerging Fund, said: “It is too soon to tell if the trade deal will materially help trading in our portfolio companies. But it offers more certainty about the UK economy and outlook. The last four years have seen international investors reduce UK exposure and many UK wealth managers also rebalance to be more global resulting in UK equities lagging other main markets. There is now an opportunity to catch up. Many of the fund’s portfolio companies are focused on enterprise services using cloud support or e-commerce. Others include companies helped by sustainability trends. I expect investment in supporting business resilience and strengthening supply chains to continue. UK economic recovery is likely to be led by government encouragement for sustainability and environmental improvement. Portfolio companies include Ceres Power and ITM Power in fuel cells and hydrogen.”

Abby Glennie, Investment Director of Standard Life UK Smaller Companies Trust, said: “Financial services is one area where there appear to still be some details to resolve. If anything this might bring opportunities for fund administrators such as JTC and Sanne as client funds may need to be realigned with the new regulatory environment. A Brexit deal may be a catalyst to encourage asset flows into UK equities, with many investors having been standing on the sidelines in 2020. Digital specialist Kainos may benefit from the increased level of red tape and new regulations required by importers and exporters as it designs the digital processes required to help businesses cope with these new regulations.”

Preparing for potential downsides

Guy Anderson, Portfolio Manager of The Mercantile Investment Trust, said: “Although the trade deal ensures tariff-free trade in goods for the foreseeable future, an end to freedom of movement could impact labour availability in some sectors that employed large numbers of EU citizens. This could include retail and food production, for example.”

David Smith, Fund Manager of Henderson High Income Trust, said: “The biggest fear was the potential disruption caused by a no-deal Brexit.  As a UK-EU trade deal has been agreed the worst of that disruption has been avoided, albeit I would still expect an increase in friction of trade moving between the UK and Europe. The majority of the companies in the portfolio have been preparing for some form of Brexit for a number of years so the impact of the trade deal is likely to be manageable. For example, food packaging company Hilton Food Group relies on workers from the EU at its facilities. With greater restrictions on the movement of labour it is likely that wage costs will increase – however, the company has been investing more in automation at its plants to help drive better efficiencies and to help offset any wage pressures. Elsewhere, specialist plastic manufacturer Victrex, which exports the vast majority of its products overseas, has been building up an inventory of finished products to be stored in the EU in case of border disruptions.”

Companies better positioned for lockdown three

David Smith, Fund Manager of Henderson High Income Trust, said: “The companies in the portfolio that are most impacted from lockdowns have all generally strengthened their balance sheets and reduced their cash burn prior to this lockdown so that they are able to emerge in a stronger position relative to competition in a recovery. For example Informa, a professional publisher and events business, raised equity, cut costs and refinanced their debt so that even if the company couldn’t run physical events outside of China in 2021, they would still be able to generate positive cash flow from the rest of the business. This puts the company in a good position to not only survive in the short term but thrive in the longer term given there is a credible path to recovery now there are effective vaccines.”

Guy Anderson, Portfolio Manager of The Mercantile Investment Trust, said: “Many of our holdings have found themselves relative beneficiaries of the lockdown environment, including ‘stay-at-home winners’ like Pets at Home, the pet products retailer, and B&M, the discounter. But we also hold stocks which are poised to benefit from a COVID-recovery in the travel and leisure sector. Given lessons from previous lockdowns, most companies are now familiar with the necessary operational protocols and, in many cases, better positioned. For example, homewares retailer Dunelm has levelled up its multi-channel proposition both prior to and during the pandemic.”

Abby Glennie, Investment Director of Standard Life UK Smaller Companies Trust, said: “Further lockdowns are disappointing and a drain on the UK economy. Some sectors, such as construction, are less impacted than previously, and for some companies lockdowns may even be helpful, such as Marshalls for example, the UK leader in block paving. Lockdown brings into question the probability of a cancelled summer holiday season, which is concerning for Jet2. However, as a market leader with a strong brand, great customer service, and a balance sheet to get them through we are confident as travel restrictions end Jet2 will be well positioned. We think the disparity between winners and losers in certain sectors will continue to accelerate. Retail is a good example. Those who went into COVID with good online propositions are well positioned to increase market share. We’d include Hotel Chocolat, Dunelm and AO World in this. But clearly many businesses still have work to do to adapt to new working environments and operate efficiently.”

Positive outlook for UK equities

David Smith, Fund Manager of Henderson High Income Trust, said: “Equity markets hate uncertainty and there has been a lot to worry about over the last few years: Brexit, General Election, US Presidential Election, US-China trade relations, slowing global economic growth and more recently a pandemic. This year there is less uncertainty and with effective vaccines being rolled out there is a credible path to life returning to some form of normality sooner rather than later. We also have a Brexit trade deal and a new US President. The global economy has moved from late cycle to early cycle in the space of six months via a pandemic-induced severe recession. With strong global economic growth expected as the recovery from the pandemic comes through and continued monetary and fiscal support from governments, I believe the backdrop is positive for UK equities especially given the starting valuation is attractive both in absolute terms and relative to other developed markets.”

Alex Wright, Portfolio Manager of Fidelity Special Values, said: “My views remain unchanged post the Brexit deal: the UK stock market and particularly UK domestic-facing stocks look very attractively priced, with many also having strong fundamentals. While the new more transmissible virus variant is a near-term concern, the body of evidence suggests it is treatable with existing vaccines. This new strain is not solely a UK phenomenon, and it is at least a European and most likely a worldwide issue. While very sadly this is going to intensify the human cost and the near-term economic damage, this should not change the course of the pandemic, which with three vaccines approved should be abating by Easter or Summer in the developed world. Thus I am making very few changes to the portfolio, simply adding to some domestic and virus-exposed names at the margin, where there is liquidity.

“Two clear catalysts that we were hoping for have now occurred: the approval of multiple vaccines for COVID and a Brexit deal. I believe both will quickly increase the interest in UK equities from domestic and foreign investors and from corporates, as we are already seeing with increased M&A activity in the UK market. Now these two key uncertainties have passed, the incredible value in UK equities cannot be ignored much longer.”

Margaret Lawson, Lead Manager of SVM UK Emerging Fund, said: “I expect a sharp UK economic recovery as the year progresses and the lockdown unwinds. Vaccination will drive this increasing confidence. Some government stimulus will continue, there is a need for many companies to replenish inventory and make further capital investment, and consumers who have been able to continue working have higher levels of savings. I believe this will trigger pent-up consumer demand for travel and hospitality and a sharp recovery. Corporate buyers may be the first to spot the value in UK listed companies. I expect more M&A activity this year. The portfolio held Applegreen which was bid for in December 2020, and I think a feature of further bids will be UK-listed companies with attractive overseas assets.”


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