- British equities near cheapest of year versus global shares
- Investors liking miners, domestic companies before referendum
U.K. stocks are posting their best performance in eight years, even as polls are increasingly pointing to a potential exit from the European Union.
The weakening of the pound and a surge in miners have helped the FTSE All-Share Index erase its annual loss, making it outrun the Stoxx Europe 600 Index by the most since 2008. British shares were the biggest gainers among regional peers on Monday, after surveys showing a lead for voters wanting to quit the EU dragged the pound to a three-week low. They rose for a third day on Tuesday.
While Bank of England Governor Mark Carney has said an exit could cause a recession, U.K. shares have remained calm, just as investors have become more skeptical of polls that proved to be so wrong in predicting the outcome of the 2014 Scottish referendum and last year’s general election. Even with the outperformance, the FTSE All-Share Index’s valuation of 15.6 times estimated earnings remains near its lowest level of the year relative to global stocks.
“The Brexit worries are well documented, the opinion polls certainly have been very erratic in the past, the outlook is OK and valuations are not excessive,” said Patrick Spencer, equities vice chairman at Robert W. Baird & Co. in London. His firm manages $151 billion. “The market is telling us that even with Brexit concern, maybe the worries are not as significant as the commentators are making them out to be.”
Ahead of the June 23 vote, Spencer favors commodity producers as he sees them benefiting from a weaker dollar and improving outlook on Chinese growth. Guillermo Hernandez Sampere, the head of trading at MPPM EK, cited the lower pound as a reason to buy the nation’s shares.
“I would buy U.K. equities due to the weak pound, which would be positive for U.K. exports, and the inflation target from the Bank of England that may be achieved earlier if the U.K. exits,” he said from Eppstein, Germany. MPPM invests only in euro-denominated companies and has 220 million euros ($250 million) under management.
JPMorgan Chase & Co. turned bullish on British stocks back in February, after being underweight the shares for three years. The bank cited their low valuations and attractive dividend yield -- at 4.2 percent for the FTSE All-Share Index, versus about 1.3 percent for 10-year gilts. If the country were to leave the EU, the weaker pound and BOE action could cushion any initial negative impact, JPMorgan said at the time. HSBC Holdings Plc raised the market to neutral from underweight in April.
Still, while British equities rallied on Monday, the volatility in the U.K. currency surged to its highest level since 2009, and investors from Australia to Thailand and Israel sounded alarm bells. Global fund managers in recent months have become even more wary of a market that was already their least favored. Their allocation to the nation’s equities has fallen to the lowest levels since 2008, according to a Bank of America Corp. survey published in May.
JO Hambro Capital Management’s Clive Beagles is among those who see some pockets of value in U.K. shares. He said he’s buying domestically oriented stocks, citing their weak performance ahead of the referendum.
While the U.K. economy is still forecast to grow 1.9 percent this year -- more than the U.S. and the euro area -- the FTSE 250 Index of mid caps trades at 15.7 times estimated earnings, near its lowest valuation since 2009 relative to the FTSE 100 Index of mega caps. The gauge tracks companies such as property website Rightmove Plc and real estate investment trust Segro Plc, which get more than 80 percent of their revenue from the U.K. Both stocks are up this year.
“The risk-reward would be favoring adding a bit to domestic names that have already been very weak in anticipation of this event,” Beagles said. “Ultimately, polls haven’t had a great record in the U.K. in the last two or three years. There is a slight danger of people overreacting.”