04 Dec 2020
Artemis UK equity income team
Capital at risk. This content has been prepared for professional investors only. All financial investments involve taking risk which means investors may not get back the amount initially invested.
The UK stockmarket led the rally in world markets last month – something that has not been the case in many years. This is not (yet) the long-yearned for return of the overseas investor, but rather that the UK has in its make-up a higher proportion of stocks and sectors that all have loved to hate since the vote for Brexit and before. Witness the fact that in the space of a few weeks, comments on the UK’s deficiency of tech stocks has been replaced with an interest in a fund’s weighting to banks.
At the time of writing, growth and value investors are slugging it out from opposite sides of the valley. The only difference is that value investors now have some live ammunition to fire, whereas before it was all blanks or mis-fires.
It has been a frenetic few weeks and one senses a danger that some will get carried away. It is almost as though many have abandoned their Elizabeth David recipe book of stock selection and are delving instead into One Pot Wonders (by Lindsay Bareham – very good) in an attempt to catch the trend.
Where do we stand in all this? As some of you know, we watch this from the col at the end of the valley with a list of stocks where we see a strong investment rationale: a variety of cashflows, prospects and valuations, rather than silos of value and growth. But yes: there are parts of the portfolio that we have kept faith with and endured value’s underperformance. We are pragmatic, and consider all aspects of an investment case. An experienced observer recently commented that growth managers would do well to spend more time looking at valuation - and value managers more time evaluating growth. We like to think that we are a composite of that.
Before and during Covid, we have been moving towards the components of the recent rally. We have made significant additions to ITV, Barclays, C&C, Informa, Drax and SSP, some of which was funded by material reductions in Segro and Relx and by the disposal of Experian. During the downturn we bought new holdings in Next and Burberry. They may not be ‘value’ per se, but we bought them at very attractive valuations, given the prospects they offer. There has also been some switching of emphasis: Rio to Anglo, BT to Vodafone ...
Our dividends have been notably more resilient then the market. Our forecasts suggest that we will emerge from this with a significant yield premium to the market and a margin over risk-free rates little different to what it was pre-Covid.
Where does the market go from here? Will it be plain sailing for value from now on? For the time being, we think the two camps may trade roughly shoulder to shoulder. Brexit (some optimism already evident here?) may provide another leg for value but likely will be good for UK equites as a whole. In our view the prime determinant for further disparate performance is bond yields. Rising yields will put further pressure on the valuation of growth stocks and certainly improve the performance of value, in relative if not absolute terms. On balance, we think this should not be ruled out: a strong recovery in growth with plenty of stimulus in place could worry bond investors (who haven’t had much to worry about for a decade or more.) But to create enduring outperformance, value stocks will need legs: that is, resilience of profits and cashflows. At that stage, the One Pot Wonders guide to fund management will have to go back to the shelf and a more discerning approach will be needed.
Finally, this dislocation of a long-established pattern may have longer term consequences. The ETFs and algorithms which have bought a consumer staple and left for the beach will be rushing back for meetings by the coffee machine. In turn, it may even curtail the relentless rise of passive investing - but let’s stop there before our objectivity is called into question.
Yields will fluctuate so income from investments is variable and not guaranteed.
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