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Over the past few years, the U.K. economy has faced difficult challenges, first from Brexit, and then from the Covid-19 pandemic. The prevailing, stubbornly high level of inflation (8% in May) has forced the Bank of England to raise its benchmark interest rate by a higher-than-expected 0.5 percentage point, to 5.0%. That’s the highest level since before the Great Financial Crisis of 2008 and, along with political turmoil in the deeply unpopular ruling Tory party, has reinforced the general view that the government is losing control. Investor pessimism about the U.K. abounds. But could that, in fact, be masking a powerful investment opportunity?
The weakness of the pound has aggravated inflationary pressures. Meanwhile, mortgage rates are back over 6%. The wave of strikes affecting industries such as the railways, healthcare, and teaching, combined with legal challenges to the government’s attempts to clamp down on illegal immigration, has added to the general malaise.
To some observers, this pessimism is providing investors with a buying opportunity. Michael Hartnett, strategist at Bank of America/Merrill, described the U.K. as the “stagflationary sick man of Europe” and urged investors to tuck away cheap and unloved U.K. companies for the next few years. “Heard anyone say anything good about the U.K. recently? Nor have we,” he wrote in a recent research note. He went on to comment that U.K. assets were cheap and reviled. Compared with global stocks, the U.K. market hasn’t been this inexpensive since 2003, he wrote.
The FTSE 100 Index sells at a p/e ratio of 14 and a dividend yield of 3.8%. This compares with a p/e ratio of 16 for the MSCI Europe Index and over 22 for the S&P 500. A low p/e is not necessarily a reason for buying, as cheap assets may be cheap for a good reason. The composition of the U.K.’s market is heavily weighted to so-called old economy sectors (19% in financials, 13% in energy, and 8.7% in materials). Less than 1% is in technology, almost the exact opposite of the tech-heavy S&P 500, let alone Nasdaq.
Of course, the same could be said of the S&P/TSX 60 Index, with its heavy exposure to financials and natural resources. The interesting point for investors to consider is that both the U.K. and Canada actually outperformed substantially in 2022, ending the year flat compared with a 20% drop for the S&P 500.
The run-up in the so-called “Magnificent Seven” large-capitalization technology stocks (Apple, Microsoft, Amazon.com, Nvidia, Alphabet, Meta, and Tesla) has seen the S&P gain 15% so far this year and the Nasdaq 30%.
But the U.K. market, as represented by the iShares MSCI United Kingdom ETF (NYSE: EWU), is actually up 8% despite all of the bad news!
The rebound in Britain may be attributed to the large number of multinational companies with global operations listed in the U.K. The largest weights in EWU, at 19%, are financials (HSBC, London Stock Exchange, Lloyds Bank, Prudential) and consumer staples (Unilever, Diageo, BAT, Reckitt Benckiser). Healthcare is at 13% (AstraZeneca, GSK). All are larger than energy (Shell, BP). Defensive sectors such as consumer discretionary and utilities comprise 6% and 4% of the ETF respectively.
Over two thirds of the FTSE 100’s revenues and earnings are from outside the U.K., either as exports or from international operations. A weaker currency is a benefit to these companies as their numbers are reported in pound sterling. In fact, the pound has appreciated by over 15% from the 35-year lows hit last October, when the selloff in gilts (U.K. government bonds) drove the pound down to US$1.05 and €1.10.
EWU has delivered an 11.2% annual compounded rate of return in U.S. dollars over the three years to the end of May, despite all of the political and economic uncertainties. The ETF gives investors a chance to buy world-class multinationals at a discounted price compared with their U.S. or even continental European rivals. Should sentiment on the U.K. become even slightly less negative, investors would benefit from an improvement in p/e multiples, while the dividend yield on EWU is 3.3%, nearly double that on the S&P 500.
In my view, EWU is a buy at present levels. Check with your advisor before investing to ensure the security meets with your risk tolerance levels and financial objectives.
Gavin Graham is Chief Strategy Officer of Calgary-based SmartBe Investments. He is a veteran financial analyst, money manager, and a specialist in international investing, with over 35 years’ experience in global investment management. This is an edited version of a longer article that originally appeared in the July 10, 2023, issue of the Internet Wealth Builder newsletter.
Notes and Disclaimer
Content © 2023 by Gavin Graham. Used with permission.
The commentaries contained herein are provided as a general source of information, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.
The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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