Invesco: UK Smaller-Companies Equities – 2020 outlook

Political and economic uncertainty has defined 2019 for UK equity investors. The recent UK General Election result provides some comfort that 2020 will be a better year for UK equities, and UK smaller companies in particular. The lack of visibility over our future trading relationships and extended sterling weakness has led to many investors shunning the UK smaller companies sector, which is disproportionately exposed to the domestic economy. The decisive UK General Election result seemingly assures leaving the European Union at the end of January 2020. Whilst negotiations with the block will continue, the strong majority won by Boris Johnson should end the paralysis that has plagued parliament. We are hopeful that this majority Government will mean an economically benign outcome being finalised: bringing much needed clarity for investors. In such circumstances we believe that the outlook for UK equities is more favourable than in recent years. Correspondingly the UK smaller companies sector, so unloved in recent years, stands to benefit most.

 

Whilst our domestic outlook is fairly optimistic, we remain more cautious on a longer-term outlook for the global economy. We believe the period of sub-par growth that has persisted since the financial crisis will likely continue in 2020. The secular drivers of the global economy are demographics, productivity and debt. GDP is a product of how many people are in work and how productive they are. For the first time in history we are seeing the working age populations shrinking in most major economies. When combined with low levels of productivity growth, it is easy to see why GDP growth over the last decade has struggled to keep pace with historic norms. Overlaying this is debt - both individual and government - which has reached unprecedented levels. The process of “leveraging up” since the early 1980s has accelerated economic growth, but it seems likely that this could diminish in future. Having been a significant headwind to the global economy in 2019, there are signs of an improvement in US-Sino trade relations. News of the “phase one deal” agrees at least a short-term truce. Meanwhile, the impending US election gives us some confidence that President Trump will seek to continue this more accommodative tone in to 2020.

Due to our conflicting views on the short and long-term prospects for the UK economy we are currently constructing portfolios based on how sensitive a company is to the economic cycle. We continue to favour stocks with “self-help” characteristics that enable them to grow independently of the economy. This can include restructuring stories, where a fundamentally good business has lost its way, but has the potential to rehabilitate itself under new management. We also like businesses that have scope to roll-out a successful concept more widely, or companies that can consolidate a fragmented industry and derive a benefit from increased scale. We also seek companies that are exposed to higher growth niches within the wider economy. These niches are often too small to make a significant difference to a large company but can represent a very significant opportunity for a small business.
The level and protracted nature of political uncertainty has been the defining near-term headwind for UK equities in 2019. We see a lot of pent-up activity in the UK economy that Brexit resolution would likely unlock. We have met numerous businesses that are taking a “wait and see” approach ahead of an agreement being reached. Given the potential political clarity 2020 could be the year of the bounce-back for UK equities. And within the smaller companies stand to be disproportionate beneficiaries of any recovery. We therefore enter 2020 with more confidence than would have been felt even just a few weeks ago.

 

Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange-rate fluctuations) and investors may not get back the full amount invested.

Important information
Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice.
This article is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities.