Last week we explained why we think Japan could offer interesting investment opportunities for investors in coming years.  This week we want to continue this focus on areas of opportunity, moving our gaze away from the far-east to somewhere a lot closer to home, quite literally.

Negative market sentiment toward any asset class can offer opportunities for investors to buy undervalued quality.  In the case of Japan, after decades of poor investment returns and rock bottom global market sentiment towards owning assets there, things have been changing under the surface and as such, it is now possible to buy high quality assets there for valuations much lower than equivalent securities in Europe or the US. 

We see a similar pattern has emerged in the UK, albeit over a shorter time frame.  Today, UK stocks trade on their lowest relative valuation compared to US stocks in history. 

The market has good reason to have pushed this discount on UK assets higher over the past decade.  In 2016 the UK’s decision to exit the EU, followed by years of political wrangling and uncertainty, damaged the economy via much lower business investment.  This peaked under the short premiership of Liz Truss when the UK’s currency suffered a sharp negative correction and UK pension funds required intervention from the Bank of England.  Add a bout of high inflation and energy price shock to the mix, and the negative sentiment toward UK assets seems justified!

Negative sentiment in markets is often accompanied by emotional responses by market participants.  This is what creates the opportunity for investors looking to buy undervalued assets.  In the case of UK assets, the aforementioned list of problems for the economy has led many domestic and international investors to throw in the towel and reduce exposure to the UK entirely for their portfolios.  This often means selling down ETFs and other investment funds which own UK assets.  As such, the prices of many UK-listed stocks have underperformed in recent years.

Many UK-listed stocks are high quality businesses and some of them are global companies, with limited revenue or profit exposure to the domestic UK market.  As such, we would argue, applying a discount to these assets to reflect a pessimistic view of the UK economy is unjustified.  These companies may have headquarters in London and stock listings on the London Stock Exchange, but they may do most of their business in America, Europe, China, et al. 

Market sentiment is often much less discerning, however.  Decisions by fund managers in New York or Tokyo to avoid UK assets means that all UK stock prices suffer, whether the underlying businesses have very much exposure to the domestic UK economy or not. 

This is where the opportunity may lie for investors.  Irrespective of one’s view of the prospects for the UK economy in the short-term, it is possible to buy high quality assets with solid businesses and stable prospects at discounted valuations, often at record low valuations, simply because of the indiscriminate selling of UK assets over the past five years. 

While we are neither bullish nor bearish on the UK economy (we take no view), we are bullish on the prospects for the prices of high-quality UK-listed assets which have low, or even in some cases, no significant exposure to a weakening in the UK economy.

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Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.

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