UK equities: a rocky road to recovery?

We discuss the outlook for UK equities.

• Despite starting the year with a Brexit deal, the outlook remains opaque.
• We could see a reversal from stocks that have rallied on hopes of a sustained earnings recovery.
• Our focus is on identifying companies with thematic tailwinds that can grow irrespective of the economic outlook.

While it was helpful to start 2021 with a Brexit deal, removing one element of uncertainty for the UK that has been hanging over us, we nevertheless entered the year with a broader range of conceivable outcomes than we have seen for a long time. One month on, the outlook remains just as opaque.

Markets are at a fascinating juncture. With unprecedented levels of monetary support, the rollout of Covid-19 vaccines, the Brexit deal and a definitive US election outcome, there is an alluring argument that we are at the foothills of a significant recovery and could see the post-pandemic uptrend in markets continue, or even accelerate, as we progress through the year.

However, it is also plausible to paint a rather more cautious outlook. As I write this, we are still very early in the vaccination journey, and the length of time we will be living with lockdown restrictions remains to be seen. Vaccinations are a significant positive step in this pandemic, but experts are clear that they will not eradicate the virus. What our ‘new normal’ looks like, or how long it takes to get there, is as yet unclear. As government-support programmes are lifted, there is a chance that more lasting damage to the economy will become evident, and we could see some reversal of those stocks that have rallied on hopes of a sustained earnings recovery.

In light of these uncertainties, we continue to focus our efforts on identifying and understanding the key multi-year thematic drivers of the world. We believe that structural trends, such as increasing consumer power, digitalisation and ageing populations, will be more meaningful drivers for UK equities over the long term than near-term economic and political gyrations.

It has been interesting to observe these themes in play during the last extraordinary year. Take Diageo for example. It reported its half-year results last week, with growth in organic sales against a pre-pandemic comparable period. This growth, while modest at 1%, was achieved despite the fact that on-trade sales (bars, restaurants) and travel retail have been so severely disrupted. In part, this can be attributed to the strength of Diageo’s business model, with the flexibility to pivot its sales efforts to the parts of the market showing the most promise at any given time. It is also a reflection of the strength of the structural themes Diageo is exposed to: consumers have choices and, whether times are good or bad, many are attracted to desirable brands and willing to spend on affordable luxuries. This is a theme which has endured over time and is proving its strength even through a global pandemic.

Another example is Smurfit Kappa. As an industry leader in paper and box packaging it is benefiting from the acceleration of e-commerce while physical shops are closed during lockdowns. This is a trend that is unlikely to reverse as stores reopen: indeed, over the last week we have seen two major UK online-only retailers acquire a number of the country’s best-known high-street brands. A significant portion of Smurfit Kappa’s end-product is from recycled material, so not only does it provide its customers with packaging solutions for e-commerce that add value, it does this sustainably. The company raised equity in November 2020 to increase its financial firepower in light of additional opportunities it sees to capitalise on these structural trends. When a business has such clear thematic drivers, it can enjoy tailwinds irrespective of the economic outlook.

We are fortunate that the UK equity market is a rich hunting ground for high-quality thematic companies. Furthermore, markets regularly misprice the value of compounding growth in these businesses. So while we may face another year of elevated uncertainty, for the selective long-term investor this may prove to be a year of exceptional opportunity.

Authors

Louise Kernohan

Head of Global Opportunities