Brexit Drama Is The Big Issue for U.K. Stocks in Second Half

(Bloomberg) -- Uncertainty over Brexit remains the big shadow hanging over the outlook for U.K. equities in the second half of the year with some fund managers seeing opportunities to buy cheap stocks, while others urge caution.

The outcome of Britain's divorce talks with the European Union, which will take place under a new prime minister, is front and center of investors' minds, not to mention low interest rates and concerns about global trade relations.

READ: In Brexit Chaos, Traders Battle to Bring Dead Money to Life

U.K. stocks underperformed their European peers in the first half of the year. The FTSE 350 index returned around 10% to the end of June, lagging behind the 13% return from the Stoxx 600. German, French and Italian benchmarks all beat Britain's FTSE 100.

Here's what a selection of what fund managers are watching out for:

Iain Pyle, investment director at Aberdeen Standard Investments

In our view, valuations are now starting to look disconnected from fundamentals: Momentum strategies and flows into concentrated growth equity funds have pushed many stocks higher despite a lack of earnings upgrades, while other names remain resolutely out of favor despite delivering encouraging updates. That creates opportunities, but to reverse the trend and deflate the bubble needs investors to reallocate away from what has worked in the recent past.

Trevor Green, head of U.K. institutional equity funds at Aviva Investors

The U.K. is already getting caught up in the China/U.S. trade wars and this could get worse in the second half of the year unless there are some major compromises made. I expect the predominately U.S.-exposed companies in the FTSE 100, mainly residing in the industrials and consumer discretionary sectors, which are minimally exposed to trade wars and Brexit, to continue to prosper and remain in favor with investors.

Michael Stiasny, manager of the M&G U.K. Income Distribution fund

Brexit's likely trajectory will affect the tenor of the market. The risk of a no-deal Brexit, and any change in the perceived chances of this happening, can weigh on domestically exposed stocks but also large international ones as investors weigh the risks to sterling. With all of the concerns that markets have about the potential global, and local, impact of many significant geopolitical events, there are good buying opportunities for active fund managers who are willing to take advantage of mispriced risk.

Tim Li, portfolio manager at Quilter Investors

One thing to look out for in the second half of the year is the possible knock-on effect of a peak in the strength of the dollar. If it does weaken then a flow of money into other currencies should naturally follow. Given the depressed price of U.K. assets and that possibility of an influx of buyers seeking exposure to non-dollar holdings, there could some headroom in U.K. asset prices. Although the U.K. looks cheap, we would caution that doesn't automatically mean U.K. assets are universally attractive.

Laura Foll, fund manager on global equity income team at Janus Henderson Group Plc

Politics is the obvious major overhang on the U.K. market, both in terms of Brexit and a possible General Election. The U.K. would remain firmly in ‘out of favor' territory among global fund managers or wealth managers and if the political overhang can be removed then there could be real upside to U.K. equities, as it becomes much less of an easy decision to ignore the U.K. market. There has been a pick-up in takeover activity in the U.K. year to date. It could be the case that if equity markets are not willing to put higher valuations on U.K. companies, then other buyers will emerge.

Laith Khalaf, senior analyst at Hargreaves Lansdown Plc

The order of the day when it comes to the macro environment in the U.K. is the continued political melodrama, and developments as we approach Brexit deadline take two on Oct. 31. There are also rumblings of an interest rate rise at some point this year, but I'll believe it when I see it. At a sector level clearly U.K. retail will likely remain in focus as we continue to see the secular trend towards digital shopping play through the industry.

Jamie Clark, co-manager on the macro-thematic team at Liontrust Asset Management Plc

Market forecasts based on political outcomes are notoriously inaccurate, so parsing the minutiae of the Conservative leadership election won't help us. Of greater importance is the general tenor of our European exit. Our base case remains that the U.K. accomplishes an orderly, soft-Brexit. This is critical to the outlook for domestic equities. It's understood that U.K. equities are cheap vis a vis other markets. Brexit's imponderables have been a key contributor to this effect. An orderly Brexit goes some small way to effacing this discount.

James Goldstone, co-manager of the Invesco Pan European Equity Income fund

The first half of 2019 has proved volatile, with extreme relative sector and style moves. The market has risen strongly on the performance of some old favorites, leaving reliable sources of growth, such as consumer staples and industrial engineers, trading at elevated levels. The polarization that now exists within the U.K. equity market between perceived winners and losers, between the value style on one hand and the growth and quality styles on the other has become even more pronounced. This environment has revealed a number of very interesting opportunities for the valuation-led investor. However, near-term catalysts for a market reappraisal remain elusive.

Blake Hutchins, manager of the Investec U.K. Equity Income fund

In the second half of 2019 amongst U.K. stocks, whilst remaining true to our investment approach, we will be watching out for those opportunities to use short-term volatility and swings in investor sentiment to add to positions or buy quality U.K. companies at cheap valuations. Additionally, we will continue to watch out for opportunities to exploit the weak sterling whilst remaining realistic about the dividend growth potential of U.K. companies which, somewhat counter-intuitively, has benefited from the weak sterling and has recently appeared optically appealing.

To contact the reporter on this story: Sam Unsted in London at sunsted@bloomberg.net

To contact the editors responsible for this story: Beth Mellor at bmellor@bloomberg.net, Jon Menon, Paul Jarvis

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