WHY UNFASHIONABLE UK DEFENSIVE STOCKS LOOK GOOD VALUE

Transcription

1 INFORMATION FOR INVESTMENT PROFESSIONALS WHY UNFASHIONABLE UK DEFENSIVE STOCKS LOOK GOOD VALUE UK EQUITIES JULY 2018 Chris Kinder Portfolio Manager, Threadneedle UK fund and UK Extended Alpha fund Expectations of stronger global growth have led to a valuation discrepancy between cyclical and defensive stocks We believe this has provided opportunities within defensive sectors, where low relative valuations coincide with a stabilisation in underlying stock fundamentals Quality UK domestic stocks are undervalued relative to UKlisted international earners, although the gap is narrowing If we were to see any mean reversion in global markets, then the UK market s greater exposure to defensive stocks relative to cyclicals should provide resilience Cast your mind back to summer 2016 and the weeks after the UK s referendum to leave the European Union. Sentiment towards the UK was overwhelmingly negative; it is unlikely that many would have predicted that two years on the FTSE All- Share index would have risen by about 25%. It also seemed unlikely that the Brexit vote would be followed by a surge in risk appetite and that, in the process, defensive stocks would be acutely devalued. Yet that is what has happened. Over the past two years, global growth has been stronger than expected, resulting in a rotation by investors into economically sensitive, internationally focused cyclical stocks. This has been predominantly funded by the sale of defensive shares, resulting in cyclical sectors trading at a substantial valuation premium to defensive sectors one that is statistically significant on a 20-year view Issued July 2018 Valid to end September 2018 Page 1 of 5

2 Figure 1: US and European cyclicals versus defensives When you have such extreme valuation and performance differentials, it does not take much for the market to mean revert. That leads to the obvious questions of when this might happen and how big the rotation will be? Neither can be answered with certainty, despite indications that global growth is starting to slow. Nevertheless, with growing uncertainty around global trade deals and lead indicators stalling in the latest periods, we have seen some signs of rotation. In the meantime, however, there is scope to take advantage of the valuation disparity by selectively rotating money into oversold defensive stocks. It is a process we have already been engaged in, shifting money at the margins into undervalued areas of the market while ensuring we maintain our balanced approach. Out-of-favour sectors One of the sectors most beaten up during the rotation out of defensives is telecoms. In Q2 the sector fell to a 30-year low relative to the market a valuation opportunity I have exploited in the strategies I manage. Within telecoms I have added to our holding in BT, 1 which was trading on a price-earnings ratio close to its 7% yield, 2 and which we believe can be maintained. 1 2 Bloomberg, 13 June 2018

3 A point to clarify is that while I may believe defensives are oversold, the decision to buy more BT and indeed any beaten-up stocks is ultimately driven by bottom-up analysis. Our investment philosophy focuses on buying decent companies at attractive valuations. Therefore, I have only increased positions in companies where there is tangible evidence of improving fundamentals and change. Within my strategies I have also added to Imperial Tobacco and British American Tobacco (BAT). 3 Like telecoms, the tobacco sector has suffered from the rotation out of defensives, as well as from sector-specific problems in its case, threats of tighter regulation and volume declines. However, Imperial Tobacco recently regained market share and BAT continued to trade well. The stability in performance of these two gave me the confidence to add to our positions. Figure 2: Out of favour but not necessarily for us Source: Morgan Stanley, DataStream, 4 July

4 Domestic opportunities UK domestic earners are another area where we see value. Since the referendum vote the differential between domestic and international stocks has become extreme. Our valuation-sensitive approach has encouraged us to selectively add some capital into domestic earners, while remaining very discerning about quality: companies are still going to have to be robust to survive in a lower-growth world. Two years ago I bought Howden Joinery for the UK strategy, correctly spotting its potential to outperform its competition and take market share. Whitbread 4 is another domestic player bought at an extremely attractive valuation, on the basis that its Premier Inn chain one of the UK s largest budget hotel chains is likely to prosper in a low-growth environment. The conglomerate nature of the group also had the potential to create incremental value. As stated, these purchases aren t part of a wholesale shift in portfolios, though a more cautious stance is appropriate at this late stage of the cycle. We have been slicing positions in the more richly valued areas of the market and reallocating to oversold, defensive and domestic stocks. A resilient market The UK remains an unloved market among global asset allocators, but we believe it remains attractive for active managers to generate strong risk-adjusted returns. Should we see a greater rotation in global markets back into defensives, then the balance of the UK market, between defensives and more aggressive cyclical stocks, should make it more resilient than its global competition. 4

5 Important information: For use by Professional and/or Qualified Investors only (not to be used with or passed on to retail clients). Important Information: Past performance is not a guide to future performance. Your capital is at risk. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. This material is for information only and does not constitute an offer or solicitation of an order to buy or sell any securities or other financial instruments, or to provide investment advice or services. This document is not investment, legal, tax, or accounting advice. Investors should consult with their own professional advisors for advice on any investment, legal, tax, or accounting issues relating to an investment with Columbia Threadneedle Investments. The mention of any specific shares or bonds should not be taken as a recommendation to deal. The analysis included in this document has been produced by Columbia Threadneedle Investments for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice and should not be seen as investment advice. Columbia Threadneedle Investments does not give any investment advice. If you are in doubt about the suitability of any investment, you should speak to your financial adviser.this document includes forward looking statements, including projections of future economic and financial conditions. None of Columbia Threadneedle Investments, its directors, officers or employees make any representation, warranty, guaranty, or other assurance that any of these forward looking statements will prove to be accurate. Information obtained from external sources is believed to be reliable but its accuracy or completeness cannot be guaranteed. Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No , Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority. Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies. UK EQUITIES JULY 2018