World’s Least Favored Stocks Shine in 2021 After Brexit Deal

(Bloomberg) -- Just as the U.K. enters another national lockdown, the stars are lining up for Britain’s long-suffering equities.

Fresh from its worst annual drop in more than a decade, the benchmark FTSE 100 Index posted its best start to a year on record. It has rallied 6.4% so far in 2021, helped by a long-awaited Brexit deal and global growth optimism. Investors are also piling into the country’s exchange-traded funds.

The trade deal with the European Union removed a key obstacle for U.K. assets just as the FTSE 100’s undervalued shares are in demand amid expectations of a global economic rebound. Many analysts and investors are looking beyond the latest pandemic restrictions, citing vaccine rollouts and the potential for more U.S. stimulus with Democrats in charge of Congress as reasons for their optimism about the longer-term outlook for equities.

“The prevailing negative investor sentiment and discount valuations attached to U.K. equities now creates some interesting investment opportunities,” said Chris Dyer, director of global equity at Eaton Vance. “The future looks brighter for the U.K. market and U.K. equities, though investors must remember that Brexit will continue to be a drag on the U.K. economy for years to come.”

Investors such as Toscafund Asset Management and Eaton Vance, as well as strategists at firms including Goldman Sachs Group Inc., Citigroup Inc. and UBS Group AG are bullish about British equities following the Brexit deal.

Cyclical Boost

Miners, energy shares and banks boosted the FTSE 100 in the year’s first week of trading. Investors backed cyclical sectors around the world on speculation additional U.S. stimulus will spur the economy under the Democrats, and oil surged after an OPEC+ compromise on production cuts. Index heavyweights such as Rio Tinto Group, Royal Dutch Shell Plc and BP Plc all rallied 13% or more.

Heavy exposure to these sectors and a slew of global franchises make the FTSE 100 one of Europe’s best recovery prospects in 2021, according to Bloomberg Intelligence strategists Tim Craighead and Laurent Douillet. In a note last week, they called the market one of the “bastions of value” across the region.

U.K. equities were the world’s most popular underweight for months, according to the Bank of America Corp. fund manager survey. Such has been the underperformance of U.K. stocks that they would need to rise by 80% relative to the world to return to their medium-term relative values, Toscafund Chief Economist Savvas Savouri wrote in a Jan. 6 note.

Manulife Asset Management’s Nathan Thooft acknowledges U.K. equities are better off on an absolute basis, but is less confident they will overtake peers because many of the “obvious” positives -- low valuations and an index tilt toward cyclical and value themes -- are shared by other regions. The relative benefit of reduced Brexit uncertainty also hinges on the magnitude of the currency appreciation and value rotation, he said.

“We expect both directionally but aren’t necessary pounding the table for massive moves,” Thooft, Manulife’s global head of asset allocation, said by email.

Even so, investors have piled into U.K. ETFs since the Brexit trade deal. The largest such fund focused on the country’s shares, the iShares Core FTSE 100 UCITS ETF, saw inflows of 183 million pounds ($249 million) in the final week of 2020, the most since March.

Shares exposed to the domestic economy were also in favor. The iShares FTSE 250 ETF saw record inflows in December, with investors bringing in almost 400 million pounds, and about 44 million pounds so far in January, according to data compiled by Bloomberg.

“Part of this may be positioning for a relative value trade, where U.K. equities are seen as strong value investments based on fundamentals,” Citigroup analyst Kim D. Jensen wrote in a note, saying investors may also have been expecting that a weakening pound could support returns for euro- and dollar-based investors.

As FTSE 250 firms’ revenues are more dependent on domestic economic conditions, the recent flows are also positioning for U.K. strength, Jensen added.