Why investors are being urged to ‘hold their nerve on UK assets’

As Brexit talks drag on and with markets likely to remain volatile, experts are optimistic.

More Brexit brinkmanship and a near two-month low for the pound hasn’t stopped a leading European bank from urging investors to hold their nerve on undervalued UK assets.

UBS Global Wealth Management said in a note to clients today that it still believes a breakthrough on a EU trade deal will come later in October, or even November.

A last-ditch deal would remove a major impediment to the UK equity market, which has been trading with the widest valuation gap to global and European peers in nearly 40 years.

The UK currently trades with a 12-month trailing price/earnings multiple of 15.4 times, which is a whopping 30% discount to the MSCI All-Country World index. But UBS is expecting a robust rebound in earnings next year, driven by an economic bounce-back and recovery in the oil price.

It said: “The UK market has a high exposure to cyclical value sectors such as energy and basic materials, which could benefit from a global recovery.

“So despite the heightened concerns over the final stages of the Brexit process, we advise investors to hold their nerve on UK assets.”

Sterling has taken a hit in recent days on fears that prime minister Boris Johnson's contentious Internal Markets Bill may derail the Brexit talks. The pound was at near 1.286 against the US dollar earlier today, down about 4% on its peak at the start of this month.

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A month before the final scheduled set of talks between the two sides, UBS said investors should expect the Brexit brinkmanship to keep volatility high for UK assets.

“But we have long believed that any deal would come only at the last minute. While it's still too early to see progress, we think that the political and economic incentives point to an agreement eventually being reached,” the bank added.

As well as optimism for UK equity markets, UBS is also positive on the medium-term outlook for sterling against both the US dollar and the euro. By September of next year, the bank expects sterling to rise to 1.40 against the greenback.

Conversely, that would represent something of a headwind for the FTSE 100 index due to the impact that a recovering pound is likely to have on dollar-earning stocks.

Morgan Stanley warned investors last week that while the UK is clearly looking cheap, equity valuations did not look especially depressed at small and mid-cap levels. It also pointed out that the recent underperformance was not just about Brexit uncertainty, but to do with the UK having one of the lowest tech stock weightings across the largest 15 markets worldwide.

That factor has kept the FTSE 100 index close to the 6,000 barrier all summer, although there was some momentum for investors today when the top flight surged 1.3% to above 6,100 after strong industrial output data in China powered mining stocks higher. Anglo American (LSE:AAL), Rio Tinto (LSE:RIO)and Glencore (LSE:GLEN) set the pace in the sector with gains of more than 3%.

Morgan Stanley also thinks the world has transitioned from a late-cycle economy to an early-cycle one over the course of this year. It expects US inflation to surprise on the upside, which traditionally favours commodities, cyclicals and financials.