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Don’t bet on a stellar 2020 for the pound – but UK stocks should do fine

With the dust starting to settle after the general election, John Stepek looks at what the new Tory government might mean for your investments.

Brexit Brings Only Pain for FTSE 100 Without Pound Magic

Markets continue to cheer the prospect of a modicum of political stability in the UK.

The FTSE 100 rose by more than 2% yesterday, while the FTSE 250 added another 1.9%.

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Of course, this morning we got a reminder that Brexit is still a discussion point, with sterling taking a knock on the news that the government will make it illegal to extend beyond the end of 2020.

But overall, now that the dust is starting to settle, what might the Tory government mean for your investments?

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Landlords don't get your hopes up

First things first, the asset class we know you all care about more than any other UK residential property.

We've heard lots of excitable stories about high-end estate agents' phones ringing off the hook (these days, I mean that metaphorically, of course), as foreign buyers flood in.

We know that agents will never miss an opportunity for self promotion. That said, there may be something to the idea of the high end rebounding.

Overseas buyers can now be much more sure of the idea that the sterling discount is as good as it gets, and that the investment environment won't get any more hostile now that Jeremy Corbynism has been roundly rejected.

So if you're a wealthy globetrotter, and you've had your eye on a pied-a-terre in a fancy bit of London, or a nice country pile to throw the occasional party in, then now is probably as good a time as any to buy.

However, if you're a residential landlord hoping that the good times will roll again, I wouldn't get my hopes up.

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The Tory government will be less painful for landlords than a Corbyn one would have been. But in this context, that's like saying I'd rather have the flu than the plague really I'd rather have neither of them.

Don't get me wrong I think the Conservatives' plans to get rid of "no-fault" evictions, and to come up with a sensible way of transferring deposits between rentals (rather than being stuck waiting for your cash back and unable to afford a deposit on another property), are good ideas.

However, it's very clear that the trend towards greater regulatory pressure and increasing responsibility being placed on landlords isn't going to change. I have no quarrel with that, but it means the business of being a landlord will get more demanding.

What about gilts and the pound?

The pound has jumped in the wake of the election, but it hasn't exactly shot the lights out. And now that the government has drawn attention back to its negotiations with the EU (the plan now is to make it illegal for the negotiation period to go beyond the end of next year), sterling has taken a knock this morning.

So while I think we've seen the low for the pound, I'd be prepared for another volatile ride in 2020. Until our future relationship with the EU is settled, I can't see sterling getting back to its pre-2016 heights. That might happen sooner than we think, but it will probably dominate next year.

As far as gilts (UK government bonds) go, I wouldn't expect a huge amount of movement in them. Or rather, I'd expect them to move roughly in line with global developed market bond yields. Which I would expect to move a little bit higher over the coming year (ie, bond prices will fall).

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On the one hand, lots of people argue that there's room for the Bank of England to play "catch-up" with other central banks in terms of cutting interest rates. And if sterling does remain stronger than it was for most of this year (even if it doesn't rocket), that'll bear down on inflation pressures.

On the other hand, does the UK desperately need rate cuts? Is credit noticeably expensive or hard to come by? Would a quarter point cut from 0.75% to 0.5% do anything?

As far as I can see it would merely leave even less room between where we are now and the negative interest rate trap, which I think most central banks would now rather avoid.

UK stocks are cheap

Finally, you've got UK equities. This is where I suspect the best opportunities lie to bet on Britain's return to the realms of "investability".

As analysts at Capital Economics point out, since the referendum back in 2016, "UK mid- and large-cap equities have underperformed those in other major markets substantially in dollar terms". Yet even if you compare in local currency terms, the UK "has still lagged the indices of other major developed markets".

As a result, the lifting of uncertainty over a) Jeremy Corbyn and b) Brexit, means there's a lot of scope for a "catch-up" play for UK equities.

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Moreover, this is happening at a time when the world in general has lagged the US. So if we get a turn on that front too, then there'll be a global impetus for money to seek out the most promising turnaround plays and on that score, the UK will be at the forefront of most fund managers' minds.

Again, sticking with Capital Economics adjusting for exposure to different sectors, the UK used to trade on the same price/earnings (p/e) ratio as the US. Now it's 25% lower.

And just to demonstrate that this isn't simply about US outperformance, markets in Europe and Japan have remained on roughly the same p/e or a bit higher than they were back in 2016. Not the UK we're well below where we were then, in terms of valuation.

In other words, we've had a big political discount hanging over us. Now that discount while not banished certainly deserves to shrink, given the emphatic majority the government now has.

As Capital Economics puts it: "with all that in mind, we think that UK equities will outperform their peers elsewhere in developed markets over the next couple of years and given their poor performance since the referendum, we think that domestically-orientated stocks in the UK will rise even faster."

We'll have more on specific ways to take advantage in the next issue of MoneyWeek magazine, out on Friday. If you don't already subscribe, treat yourself for Christmas and get your first 12 issues for £12 here.

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