Mike Coop: Should investors shun U.K. assets and seek shelter in US. assets, if there's a no-deal Brexit, and trade with the EU moves from current EU terms to WTO terms? This is the question markets have been asking and tell us with the relative underperformance of UK equities, fall in the pound and gilts outperforming global government bonds.
We know that forecasting economic turning points is unreliable and political decisions have surprised investors repeatedly. So, favouring better-value markets that are out of favor and have tended to be a better way of generating sustainable returns and then stress-testing portfolios to see how they might behave in extreme conditions. If you take this approach, UK. equities look attractive whilst gilts and the US dollar do not over a full market cycle.
The UK stock market is not the UK economy. 70% of revenues come from outside the UK and the fall in the pound makes these offshore revenues bigger in pound terms. The banking sector here has gone through a long period of recapitalising and ongoing stress tests. So, they are better placed to withstand big domestic shocks than before. Energy and mining companies are benefiting from reducing their cost structures in response to big falls in commodity prices several years ago.
Compared to other equity markets, the UK equities are better valued and there's scope for profits to grow. U.K. gilts still offer very low interest rates for investors, pretty much locking in negative returns after inflation whilst returns from cash are creeping up as interest rates rise. So, we hold less in gilts than usual as the very long duration of gilts means rising rates can quickly translate into losses.
Finally, there's the pound, which is now close to the lows versus the US dollar seen in the wake of the referendum vote. While investors have enjoyed currency gains this year, the pound is so low versus the US dollar now that it is very undervalued and historically, this has been followed by a rise in the pound and currency losses. So, we are being cautious about the outlook for the US dollar over the medium term and hold fewer dollars than usual to protect our portfolios.
