Overview
UK equities have long been out of favour. Brexit uncertainty led to years of outflows, while the market has also suffered from its lack of exposure to tech stocks. More recently, the pandemic meant that two thirds of UK companies had to cancel or cut their dividends between Q2 and Q4 last year.[1]
The Brexit deal in December was meant to mark a turning point. But it seems that much of the boost was already priced in. The FTSE All Share index has lagged the global market since then, weighed down by a wave of Covid-19 infections and concerns about new variants.
This week's Chart Room looks at how this pessimism has been reflected in valuations. Compared to other regions, the UK market trades at the lowest one-year forward price/earnings premium versus its 10-year average. This is despite the fact the UK’s 4 per cent dividend yield is double the global average.
A cyclical recovery may be on the cards
Yet Covid-19 cases are now falling in the UK and initial research suggests that some vaccines remain effective against some of the new strains. Although the Bank of England has cut its 2021 growth forecasts, they still suggest a successful vaccine roll-out will pave the way for a rapid recovery in the second half.
That bodes well for UK equities. The market has a large share of growth sensitive sectors such as energy and banks, which have the potential to do well as reflation gathers pace. Forecasts suggest the recovery in UK earnings could be the strongest among developed markets. Flows into UK equities have also started to pick up, creating a technical tailwind. Importantly, defensive sectors like consumer staples and healthcare also have large weightings in the stock market, offering some protection if the reopening is slower than expected.
UK dividend yields may also begin to appeal. UK dividend futures fell recently, suggesting that pay outs are still under pressure and could lag those in other regions. But some UK companies, including telecoms and commodity-related businesses, could start to divert free cash flow towards dividends again as they recover further from a tough 2020.
[1] https://www.linkgroup.eu/insights/publications/uk-dividend-monitor-q4-2020/
