Bounce back better – outlook for our AiM portfolio following Brexit

With a free trade deal agreed, for goods at least, a key reason or excuse for overseas fund managers shunning UK assets has been removed. With the sword of Damocles (mostly) back in its scabbard, we should expect most or all of the £50bn that has flowed out of UK equities since 2016 to now return. As long as vaccines don’t prove to be totally ineffective, the market will now increasingly price in a return to normalisation, where the economy ‘reflates’ as lockdown measures ease and the economy reopens. Talk of a return to the ‘roaring 20s’, when the world was recovering from Spanish Flu, may be premature but the outlook is undoubtedly bullish. While such a viewpoint is highly consensual – normally a time to pause and reflect – we believe that this time the consensus is right!

As the old adage goes, ‘history doesn’t repeat but often rhymes’, so too with recessions; they never mirror each other exactly but we can use previous episodes to provide a recovery roadmap. The cause of this recession is well known, but what of its effects? A unique feature of the enforced lockdowns was a huge disparity in terms of the impact it had on businesses and people. Some businesses actively benefited from the crisis, while others hunkered down, desperately trying to survive until the economy reopens. Rather than figure out how to win the last war, investors at this point in the cycle would be far better served targeting last year’s laggards, as many of its winners will find it difficult to maintain momentum against tough earnings comparatives.

For those workers who kept their jobs, incomes held up remarkably well but couldn’t be spent, leading to a spike in the savings ratio, peaking at an unprecedented 30%. This points to a more rapid than normal rebound in economic activity as lockdown conditions are eased and they can again spend, spend, spend. Travel, Leisure, and Retail stocks are well poised to benefit, but we favour only the most financially robust, particularly in sectors where competition has recently exited the market. These sectors could also benefit from: cost savings sticking, a dramatic fall in rental payments, and even business rates reform. Maybe it’s a good thing to be a nation of shopkeepers after all?! Those brands that can portray authenticity and connect at a local level are particularly well poised.

We are already seeing bottlenecks in supply pushing input costs up across a range of industries, historically bullish for the industrial stocks providing them with rare but transient pricing power. Cyclical stocks/sectors such as consumer discretionary (Portmeirion Group), support services (Augean) and industrial engineering (Avingtrans) look well poised to see their valuations revert to average levels, and may indeed overshoot on the upside, as earnings growth comes through strongly from a very low base. Typically, these sectors have been under-owned by investors, scared off by their inherent volatility in earnings. When the wider cycle has turned though, that volatility becomes a virtue.

Brexit stymied capital expenditure (CapEx) significantly, and with 4 years of catch-up and a more stable backdrop, rising CapEx will further benefit the more cyclical, cheaper industrial-type stocks such as hoses and pneumatic distributor Flowtech Fluidpower, as opposed to expensive, faster-growth companies like on-line retailer BooHoo, or data software group, YouGov. Growth at more reasonable prices should prove a better bet going forward than out-and-out growth at any price (Tesla anyone?).

The pound is already starting to normalise in value. This may trigger a final stampede of takeover activity by overseas buyers keen to take advantage of a currency still some 10-15% below fair value and relatively cheap UK valuations. A tilt more towards domestic earners – who would benefit from a stronger £ in contrast to overseas earners – seems a sensible bet. Within our investment universe, we continue to see the very strongest value at the smaller end of the market, a segment that does particularly well in the early stages of an economic recovery when risk appetite is most elevated.

All told, we see the strongest outlook in years for our portfolio holdings. Boris and Co. may ‘Build Back Better’, but UK small cap equities are set to ‘Bounce Back Better’.

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Written by Stephen English


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