Overlooked UK stocks maintained their robust start to 2021 today, adding some fuel to hopes for a reversal of fortunes in the FTSE 100 index after years of underperformance.
Gains of 2% for heavyweights BP (LSE:BP.) and Royal Dutch Shell (LSE:RDSB) lifted the top flight 0.4% at one stage after vaccine optimism sent it rocketing more than 1.7% on the first trading day of the year.
Yesterday’s improvement was in sharp contrast to Wall Street, where the Dow Jones and S&P 500 fell back from record highs on the back of an uncertain US political outlook.
It’s still early days, but the about-turn in performances is in line with a widely-held City view that the laggards of 2020 are set to become outperformers this year. Areas identified with the most catch-up potential include the UK stock market – the FTSE All-Share index fell 12.5% last year compared with a rise of 16.3% rise in global stocks.
Brexit and the top flight’s weighting towards oil and gas and financial services during Covid-19 meant the FTSE 100 index fell 14.3% in 2020, despite a rebound in the final quarter.
City broker UBS is backing the FTSE 100 index to rally as far as 7,200 by the end of 2021 – that’s up around 10% – based on expectations that the interest of international investors will finally return to the UK following the EU trade deal. It noted recently that 18 out of 24 sectors in the UK currently trade on larger price/earnings discounts to their European peers than their 15-year average.
Mark Haefele, chief investment officer of UBS Global Wealth Management, added today: “The UK market has a bias towards cyclically sensitive stocks, and risks from Brexit that have been holding stocks back were removed by the trade deal with the EU.”
Global economic recovery hopes have certainly helped commodity stocks at the start of 2021, with the weaker dollar also a factor ahead of Georgia run-off elections. Success for the Democrats would boost the chances of President-elect Joe Biden getting more of his agenda through Congress, with any additional fiscal support set to pressure the greenback.
Gold and silver prices have strengthened on the back of the weaker dollar and after the US Federal Reserve made it clear it would allow inflation to overshoot in order to support the economic recovery.
The favourable conditions have put gold back in sight of the $2,000 level, helping shares in Russia’s Polymetal International (LSE:POLY) to rise by 9% yesterday and Mexico-focused silver producer Fresnillo (LSE:FRES) to jump by more than 10%.
Rising commodity prices, including Brent crude above $50 a barrel, have the potential to stir up fears about a return of inflation, particularly when equity market valuations are built on the presumption that near zero interest rates will persist for some time yet.
Schroders’ chief economist Keith Wade said last week: “This benign outlook assumes inflation only rises slowly to reach 2% at the end of 2023. However, if inflation comes back quickly and is sustained, there would have to be a reappraisal of the outlook for policy.”
Rising unemployment caused by Covid-19 will keep wages in check but Wade warns about a longer-term threat should central banks misread the structural impact of the pandemic.
“Markets will continue to worry, but the low rates for longer view should hold through 2021 and potentially beyond,” he added.
For now, however, the outlook for company earnings and potential return of dividend income is very much clouded by the pandemic, particularly in terms of predicting levels of joblessness, housing market prospects or the exact extent of stimulus measures.
The UK-EU trade deal has at least provided some clarity, especially for those mid and small cap stocks exposed to the domestic economy. Recent deals for RSA Insurance (LSE:RSA), William Hill (LSE:WMH), and G4S (LSE:GFS), as well as yesterday’s £8 billion offer from MGM Resorts for Ladbrokes owner Entain (LSE:ENT), highlight that Britain’s companies are attractive to overseas buyers.
According to the Times newspaper, analysts at Canaccord Genuity see a string of household names including ITV (LSE:ITV) and Crest Nicholson (LSE:CRST) as potential targets for private equity buyers.
Sue Noffke, head of UK equities at Schroders, added prior to the Brexit deal: “The reasons for owning UK shares are much less well-known and have frequently been overlooked. It seems to me that the bad news is crowding out the good. This, in part, explains why there are so many mispriced opportunities at present.”