Vaccines Aren’t Enough to Keep British Stocks Exciting

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Investors have done well out of the U.K. reopening trade. The reversal in fortune for many domestically-focused stocks has been sharp. But the easy money has probably already been made.

Since Nov. 6, the last trading day before Pfizer Inc. cheered the world with positive Covid vaccine results, U.K. stocks have performed strongly. The FTSE 250 index, traditionally seen as a better domestic indicator than the FTSE 100, is up 18%. It’s beaten most major international benchmarks in local currency terms. Across both indices, stocks with at least two-thirds of their sales coming from the U.K. have done even better, rising on average 25%, according to data compiled by Bloomberg. Within that group, cyclical sectors like financials and housebuilders have shone.

The more recent gains here reflect the U.K.’s aggressive vaccine rollout. Prime Minister Boris Johnson has a timetable for ending lockdown, starting with schools resuming in-person this week. But the upswing is mainly a reflection of just how badly the U.K.’s largely services economy got hit by the pandemic: The FTSE 250 was among the worst performing indices when the virus struck. The bounce-back simply puts it on par with the wider European stock market in terms of valuation and performance since late February 2020. 

The U.K. plans to lift all restrictions on social contact by late June, depending on the trajectory of infection rates. Stocks moved more in anticipation of this than after the aspiration was announced last month. Much now depends on earnings forecasts ticking higher if stock gains are to continue. Yet it remains unclear what lasting damage the pandemic will inflict on the U.K. economy. Frictions imposed by Brexit, currently out of the headlines, could starting creeping into corporate commentary.

What about sterling? It’s been a beneficiary of getting a Brexit deal finally done, and this has amplified recent returns on British assets for overseas investors. The stability of the currency has doubtless removed a deterrent against international investors buying U.K. stocks, but even amid prevailing dollar weakness, it may not be positive incentive to do so.

Of course, there are still good arguments for U.K. equities as a whole, including the more internationally focused large-cap stocks: They remain very cheap on a relative basis. Higher government bond yields driven by global economic recovery would favor markets with weightings to so-called value sectors like the U.K.’s, over the more growth-oriented U.S., as strategists at Citigroup Inc. point out. The FTSE 100 is on 15 times forward earnings; the S&P 500 22 times. It’s a defense based largely on London’s dull “old economy” composition.

But tellingly, the M&A market has so far shown little enthusiasm for pure-U.K. stocks. The companies that buyout firms have been picking off have some reopening appeal but generate only a minority of their revenue in their home market — mid-cap stocks like security firm G4S Plc, private jet refueller Signature Aviation Plc and Aggreko Plc, which rents out power generators for events. The revaluation of U.K. domestic stocks has been rapid in recent weeks. The longer term challenges they face haven’t gone away.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

©2021 Bloomberg L.P.

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