Investors fleeing UK equities in 2016 have missed out on healthy gains. Absolute performance to the end of July has been strong, with the FTSE All-Share Index delivering an 8.45% return. This is, however, significantly behind the 16.46% return of the MSCI World Index during this period.
The main talking point among equity managers in the past months has been the impact of the EU referendum. Prior to the vote, there had been a shift in equity market leadership in 2016, with the largest companies, represented by the FTSE 100, outperforming the mid-cap FTSE 250 after having lagged behind for four calendar years.
With significant rises in spot prices, the oil & gas and mining sectors outperformed the broader market by a significant margin during the first half of the year, having had a torrid time in 2015. The food retail sector, another deep value play, also showed signs of recovery. There was also a less pronounced switch away from some areas that had performed well in 2015.
And so to Brexit. Heading into the referendum there was some minor weakness in more cyclical domestic names but, following the leave vote, markets downgraded stocks with a domestic cyclical or financial bias, reflecting a predicted slowdown in the UK economy as consumers and corporates curtailed spending due to an unclear outlook.
Retail, banking, travel and leisure sectors were all hit hard, while real estate investment trust (Reits) and property-related companies were also significantly de-rated.
Defensive sectors were the beneficiaries, while stocks with overseas rather than domestic earnings also benefited as the falling pound produced upgrades to earnings.
Sectors such as pharma and biotech, tobacco and beverages benefited from both effects, while others such as mining and oil & gas producers were beneficiaries of US dollar earnings.
Overall, the managers we have spoken to regard the size of moves and the speed of reaction to have been efficient, although there have been some opportunities lower down the market-cap scale.
The FTSE 250, and smaller-cap companies in general, have a greater exposure to domestic earnings –close to 50% for the FTSE 250 Index compared with 30% for the FTSE All-Share Index – and as a result that part of the market has underperformed since the 23 June referendum to the end of July.
There was some indiscriminate selling of these areas of the market initially, but the subsequent rise in index levels is evidence of these issues working their way through.
The initial reaction to Brexit is an enhanced version of the consensus prior to the vote, that the economy is likely to show a protracted period of low growth but there is a question mark over the level of growth.