U.K. Equities Will Continue To Lag The U.S.
U.K. equities have underperformed their U.S. counterparts since late-2007. Even though the U.S. was the epicenter of the financial crisis, the U.K. economy suffered a deeper recession and has witnessed a far more anemic expansion since 2009. The U.K. is currently flirting with near-recessionary conditions and prospects appear poor given the economic problems in the euro area, domestic fiscal drag and a relatively passive BoE.
The U.K.’s many woes are well known, yet policymakers have been unable and/or unwilling to stimulate growth. Global investors have noticed and generally stayed clear of U.K. equities (and the currency), despite the market’s historically defensive characteristics. In addition, the U.K. market has been held back by the relatively poor performance of mining and energy shares. The U.S. economy has also been fighting economic headwinds, but has managed to outperform the U.K.: the sizable growth gap between the two countries is driving a wedge between equity market performance, especially when measured in U.S. dollars.
The new head of the BoE offers a small glimmer of hope for the U.K. Governor Mark Carney got off to a rousing start and has managed to calm bond market worries about a premature change in monetary policy. This, in turn, has opened a small divergence between the BoE and the Fed, with the latter set to start slowing its asset purchases, perhaps by this autumn. Carney can be expected to argue for a more aggressive policy stance in order to stimulate the economy and, based on his experience in Canada, he will not take any risk that might burst the housing bubble. His bias will be to downplay the inflation risks associated with a weak currency, at least until the economy is in much better shape.
Looking forward, the hope for the U.K. economy is that conditions finally stabilize on the continent later this year, and the global trade cycle gradually improves. Until then, investors should continue to overweight the U.S. relative to the U.K. in a global equity portfolio, and to favour the U.S. dollar versus the pound. A reversal in fortunes is not yet on the horizon, but keep an eye on the BoE and leading economic indicators.
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