Will Brexit Blight British Stocks in 2018?

Neptune's Head of UK Equities Mark Martin looks at what drove the UK stock market in 2017, and where investors in domestic stocks can find gains this year

Neptune 2 January, 2018 | 12:26AM
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Will Brexit blight British stocks in 2018?

Brexit negotiations weighed on consumer confidence in 2017. After several years of high levels of consumer confidence, cracks emerged as house price growth in many regions stalled and the Bank of England raised interest rates for the first time since 2007.

The rise in interest rates appeared to reflect the Bank of England’s concerns around elevated consumer debt levels and the inflationary pressures of weak sterling, rather than any marked improvement in the prospects for the UK economy.

Inflationary pressures also continued to build. Labour shortages as well as the impact of living wage increases, and apprenticeship levies, were particularly painful for companies that have a high proportion of labour costs, such as restaurant and pub companies. These are companies we typically avoid in our UK funds. Real wages fell in the UK as the effects of inflation countered modest nominal wage growth.

Despite the multiple headwinds that the UK economy faced in 2017, UK stock markets performed well in absolute terms and the mid and small-cap parts of the market performed relatively well compared to the broader UK market. The strong relative and absolute performance of the FTSE 250 Index reflected relatively low valuations for the index, and bearish sentiment, at the start of the year.

It is also important to remember that the constituents of the mid cap index in aggregate generate approximately half their revenues from outside the UK. Encouragingly, smaller companies within the UK market also benefited from increased merger and acquisition volumes.

2018 Outlook

Volatility: Recent years have seen a marked decrease in volatility measures across most asset classes. This has likely been caused by multiple factors, including ongoing ultra-low interest rates. Whilst we do not expect interest rates to increase materially in the UK, even a small increase in rates could cause consumer stress and increase volatility. Over the short-term, low volatility can beget low volatility, elevated confidence and elevated asset prices. Over the longer term, however, low volatility can in fact beget higher volatility. Investors should bear this in mind and invest on an appropriately long timescale.

Politics and geopolitics: The Tory party faces undoubted challenges over the course of 2018 and it would be dangerous to assume that domestic politics will be less complicated in 2018 than 2017. The prospect of a general election in 2018 should not be ruled out and any further improvements in the chances of Jeremy Corbyn as the next Prime Minister would likely cause ructions in domestic stock- markets. Global geopolitics may also become more complex in 2018 as tensions rise in Asia and the Middle East in particular.

Few prospects for much improvement in consumer confidence. Unemployment levels are already low and house prices, whilst very expensive compared to history, are beginning to weaken in some parts of the country.

Combined with the prospect of high consumer debt levels, rising interest rates and potentially rising inflation – not to mention a complex negotiation process with the EU – it is hard to see why consumers in the UK should become much more confident than they already are.

Although valuations are low for certain domestic cyclical stocks, we are continuing to avoid the broader sector. Instead we are focusing on overseas earners and those domestically-focused companies that are exposed to non-discretionary spending within both UK funds.

The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring on our website, please email submissions to UKEditorial@morningstar.com

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Neptune  is an independent and privately owned investment management company, founded in 2002 by Robin Geffen.

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