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LONDON — JPMorgan has upgraded U.K. stocks to “overweight,” ending years of caution on British equity markets which the bank said are now trading at a “record discount.”
The Wall Street giant had held a longstanding cautious call on U.K. equities since the Brexit referendum in 2016, before moving to “neutral” in July 2020 after a particularly dire spell for U.K. stocks and after the worst of the coronavirus pandemic.
With U.K. equities having delivered a more range-bound performance against their transatlantic and European peers over the past 12 months, however, JPMorgan on Monday upped them to overweight in both a European and global context.
Since the Brexit referendum, U.K. equities have lagged the U.S. by a cumulative 50% and the euro zone by 24%, JPMorgan Head of Global and European Equity Strategy Mislav Matejka highlighted in a research note.
JPMorgan’s aggregated data showed that the U.K. has opened up a “record discount” versus other regions, both on a price-to-earnings and a price-to-book basis. The former helps determine the market value of a company’s stock relative to its financial results, while the latter is relative to the book value of the company’s equity.
The discount holds even when value sectors — those which generally trade at a discount relative to their financial fundamentals — are taken out.
“Within the U.K., we held a longstanding preference for FTSE 250 vs FTSE 100, and for
domestic vs exporters. We now think FTSE 100 could perform better,” Matejka said.
Matejka’s team is funding the upgrade by cutting its exposure to Japan, and picked 25 U.K. stocks to best capitalize on the catch-up trade. These include such high-profile names as BP, Barclays, Jupiter Fund Management and Vodafone.
Diverging fortunes
JPMorgan’s new overweight position in the U.K. follows a long-held view for European equity analysts at British rival Barclays, who are also overweight the large cap FTSE 100 for its export-heavy composition, but underweight the more domestically-weighted FTSE 250.
This diminishing faith in domestic small-cap stocks was echoed on Tuesday by Credit Suisse, which reduced U.K. small caps to underweight while boosting their U.S. peers to overweight.
“U.K. small caps are much more cyclical and more domestic than large caps, yet U.K. small caps have barely reacted to the decline in U.K. PMIs (purchasing managers’ index), which could well have further to go,” Credit Suisse strategists said in a research note, adding that British small caps are pricing in a PMI of 62, versus 57 currently.
“The UK faces a range of idiosyncratic supply-side challenges with a more hawkish central bank, which could lead to GDP forecasts for next year coming under more downward pressure than in other regions.”
Credit Suisse highlighted that British small caps often perform badly when sterling falls, and currently seem to be discounting a decline in credit spreads, which strategists see as “unlikely.”
“Despite these risks, small caps continue to trade at a very large valuation premium to large caps vs their history,” they added.
Steve Brice, chief investment officer at Standard Chartered, told CNBC last week that the bank’s chief concern about the U.K. equity market was whether the Bank of England would “overreact” to persistently high inflation, which it now expects to top out at 5%.
The central bank last week held off on an expected hike to interest rates, opting to wait and assess labor market data after the end of the U.K.’s furlough scheme. However, markets broadly expect an imminent hike.
“Obviously there is supply bottlenecks globally, but they are being extenuated in the U.K. from Brexit as well, so it is not a preferred market of ours from an equity market perspective,” Brice said.
“If anything, it is our least favorite market when we look around the world today, because of those policy risks.”