U.K. Stocks Lag Europe as Valuations Fail to Draw In Bulls

(Bloomberg) -- U.K. equities can’t seem to catch a break.

Even as the market trades near its cheapest since 2014 based on forward earnings, most investors aren’t biting. The FTSE 100 Index is trailing other major Western European equity benchmarks this year, down about 7 percent versus the Euro Stoxx 50 Index’s decline of 3.6 percent.

Worries over the outcome of Brexit and domestic political squabbles have pushed pessimism toward the equity market to financial crisis-level highs. That’s as bearish bets on stocks in the FTSE 350 Index increase amid the latest selloff, resulting in the largest position for short sellers in U.K. equities since the first quarter of 2009, according to IHS Markit Ltd.

“One of the reasons why the U.K. is a bit cheaper than other markets is that global investors are still undecided about what Brexit means for U.K. Plc and that uncertainty probably isn’t going to disappear in the next 12 to 18 months,” said Charles Burbeck, a deputy portfolio manager at UBS Asset Management in London. “We like to focus on company fundamentals, but we have to be mindful of that.”

U.K. Stocks Lag Europe as Valuations Fail to Draw In Bulls

Shares in U.K. retailers including Tesco Plc, J Sainsbury Plc, Next Plc and Marks & Spencer Group Plc fell on Thursday after John Lewis Partnership Plc said the weak pound and higher costs will squeeze its profit this year. Real estate broker Countrywide Plc plunged after saying its first-half profit will decline because of a significant drop in its pipeline.

Equity strategists see the relative weakness of U.K. stocks continuing, predicting less upside for the FTSE 100 than for euro-area peers through end-2018, data compiled by Bloomberg show.

Bearish sentiment has spread as the argument that a weaker pound protects U.K. stocks against political turmoil becomes stretched. The FTSE 100’s relationship with the currency is becoming more unpredictable: while the asset classes have tended to be inversely correlated due to U.K. companies’ hefty overseas sales exposure, that correlation has crossed into positive territory twice this year.

Fading Earnings Boost

Strategists at JPMorgan Chase & Co. and UBS Group AG have argued in recent months that the boost from a weaker sterling -- which propelled the benchmark to a 14 percent gain in 2016 -- may have reached its limit. Proof of the banks’ argument can be found in U.K. earnings estimates. Analysts expect FTSE 100 members to grow profits by 4.8 percent in 2018, in line with the 4.6 percent projection for the Euro Stoxx 50, and by less than the euro-area gauge in 2019, data compiled by Bloomberg show.

“The U.K. earnings outlook is not as bright as in other regions, such as the eurozone or the global equity market,” Caroline Simmons, deputy head of the U.K. chief investment office at UBS Wealth Management, wrote in a February note. “We anticipate the U.K. underperforming the eurozone and global equities over the next six months.”

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