How to play the Boris bounce – the British stocks to buy in 2020

Whatever else Boris Johnson has planned, one thing is clear – after years in the cold, it’s time to buy Britain, says John Stepek.

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This time last year, Britain looked virtually ungovernable. Theresa May had just survived a "no confidence" vote in the House of Commons, but her days as prime minister were numbered. With open rebellion in her own party and no way to pass her Brexit deal without getting entangled in one party or another's thicket of "red lines", the UK was gridlocked.

Fast forward to today. With the Conservatives, under Prime Minister Boris Johnson, securing a majority of 80 seats far more than expected Britain now has its first "solid majority government" in 14 years, as Helen Thomas of BlondeMoney puts it. Not only that, it's the first such Conservative government in 32 years. It is no exaggeration to say that "this will completely change the outlook for the country". What happens now? And what does it mean for investors?

The new politics

The most obvious change is on Brexit. Johnson's withdrawal agreement is set to go back in front of parliament on Friday 20 December, where it should now pass easily. So Britain will leave the European Union (EU) on 31 January. A "transition period" during which to negotiate a new deal with the EU then follows. The aim is to have this wrapped up by the end of next year if not, the relationship will be governed by World Trade Organisation (WTO) rules. The government has formally ruled out any extension to the deadline, with the goal of focusing minds on getting a deal done quickly and also on showing to sceptical "leave" voters that Johnson is serious. That means markets still have the spectre of a "hard Brexit" to fret about but at least they know that the process has a genuine end point to prepare for now.

Another big shift is that the government will be spending a lot more. One focus will be the north and the Midlands, where lifelong Labour voters turned Conservative rather than vote for Jeremy Corbyn. The new government will want to make sure that those voters don't suffer buyers' remorse, which for now looks to mean billions in extra spending on improving the rail network in particular. The other beneficiary is set to be the NHS, with the government committing to spending an extra £34bn on the health service by the 2023/2024 tax year. The Office for Budget Responsibility the UK's public spending watchdog is unlikely to welcome it, but Chancellor Sajid Javid (like every single one of his predecessors) will no doubt find a way to finesse the situation so that it looks as though the government is sticking to one made-up fiscal rule or another, when he finally gets to deliver his first budget in February or early March.

Finally, there's the shake-up of the civil service, under Dominic Cummings, the strategist behind both the Conservative victory and the "leave" vote in 2016. Cummings has often criticised the civil service in lengthy blogs on the topic now he has the chance to put his ideas on improving things into practice. Overall, reports the Financial Times, the idea is "to help develop a post-Brexit economy focusing on boosting northern England and to update UK foreign policy based on the concept of global Britain'". So far that includes, among other things, a new energy and climate change department.

What does it all mean for investors?

From an investment point of view, the election has already achieved two main things. Firstly, it has removed the need to apply a "Corbyn discount". The share prices of companies in the sectors most at risk of nationalisation under a Labour government have been the ones to recover most resoundingly following the vote. And more broadly there is general relief that the UK has reaffirmed its commitment to free-market capitalism, rather than a return to widespread state ownership and punitive taxation. So from that point of view, the UK is no longer "uninvestable", as some particularly excitable analysts have suggested at various points over the last few years.

Secondly, it provides some certainty on the Brexit process. You may or may not be happy about Britain's decision to leave the EU and the end-state of that relationship is not yet clear. However, we do at least know that the UK will be leaving. And while the process will have several ups and downs over the coming year Johnson's plan to rule out an extension beyond the end of next year is already rattling markets afresh the fact that the British negotiators will no longer have to contend with being undermined at home at every turn also means the direction of travel during the process will be clearer. If nothing else, the sense of sheer pandemonium that prevailed throughout the last couple of years is now over.

How does that translate into markets? First, the pound. Sterling will bear the brunt of the ups and downs of the Brexit negotiations next year. So, as Capital Economics suggests, until our future relationship with the EU is done and dusted which will probably take most if not all of next year to sort out the pound may not strengthen drastically. That said, they do expect it to reach $1.40 by the end of 2021. And in the longer term, a stronger pound seems like a good bet. Alessio de Longis at Invesco Investment Solutions tells the Financial Times that "pound strength will continue fundamentally for years to come" as capital returns to the UK, helped by "a slowly changing tide in favour of non-US assets". He reckons the pound will gain 7%-8% a year from here.

Secondly, gilts. The Conservatives don't plan to spend as much as Labour would have, but they're still planning to spend a lot more than we have been. Looser fiscal policy would normally suggest higher government bond yields, and that's probably what we'll get. That said, don't expect any drastic moves the biggest driving force for gilt yields will still be whatever's going on in global bond markets. While global rates remain low, gilt yields will too.

Don't bet on a big bounce back for house prices

Thirdly, house prices. If you're selling a property in a prime area of the UK, particularly London and the southeast, you can expect an easier ride this year. Overseas buyers are no longer being put off by the threat of a Corbyn government and have also realised that the pound's nadir is probably now in the past. The Daily Mail reports on how one Hong Kong multi-millionaire paid £65m for a six-bedroom property in Belgravia on the day the election results came out.

However, if you're a residential landlord hoping that the good times will return, I wouldn't get your hopes up. The Tory government will be less painful for landlords than a Corbyn one would have been. But given how hard the Conservatives have already been on landlords, that's not really saying a lot. The government plans to get rid of "no-fault" evictions, create a system whereby deposits can be transferred between rentals, and impose further rules on energy efficiency. None of this is bad. But it is clear that the trend towards greater regulatory pressure on landlords won't change. So don't expect a revival in buy-to-let.

On a wider point, governments are realising that soaring house prices are no longer a political necessity, but a political liability. The government will hopefully realise that its efforts should focus on increasing good quality, affordable housing supply in areas where it's needed, rather than propping up prices through ill-considered schemes such as Help to Buy.

The sectors and funds that should benefit

Equities are arguably where the greatest opportunity lies for investors. As Capital Economics points out, since the referendum in 2016, "UK mid- and large-cap equities have underperformed those in other major markets", whether you measure in dollar terms or local currencies. That means there's a lot of scope for UK equities to play catch-up with the rest of the world. For example, pre-2016, the UK traded on roughly the same valuation (as measured by the price/earnings ratio) as the US. Now it's 25% lower. Moreover, this is happening at a time when global investors are starting to wonder if it's time for the rest of the world to break its long period of underperformance against the US. That suggests a lot of money will be seeking the most promising turnaround plays and the UK fits the bill.

What should you buy? You could opt for a simple UK tracker fund Capital Economics reckons the UK MSCI index will rise by about 17% by the end of 2021, versus around 10% for the US and Europe. But if you're looking for more specific exposure, then domestically focused small companies are the ones that have lagged the most. Options include BlackRock Throgmorton Trust (LSE: THRG), BlackRock Smaller Companies (LSE: BRSC) and Henderson Smaller Companies (LSE: HSL), all of which have stellar ten-year records. For a direct play on mid-caps, the FTSE 250-focused Schroder UK Mid Cap Trust (LSE: SCP) has done well over the past year, but still trades on a discount to net asset value of 8%.

Another option is to go for a value-focused UK investment trust one that invests in the companies with most scope for recovery. One that we regularly mention is Temple Bar (LSE: TMPL). One of the fund's top holdings is outsourcing group Capita, which analysts at Mirabaud earlier this year singled out as a strong stock pick for anyone looking for cheap companies that could benefit from extra UK government spending. Temple Bar also owns most of the UK's high-street banks, all of which should be helped by both the lifting of the Corbyn discount and the added clarity on Brexit. Alternatively, you could opt for the Aurora Trust (LSE: ARR), which has a similar bias towards value investing. However you decide to get exposure, we'd argue that with the pound likely to rise in the longer run and relative political stability on the cards for several years, now is almost certainly a good time to increase your allocation to UK equities in your portfolio.

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