If you're looking for a contrarian investment in the current market, there is one country that sticks out more than most.
U.K. equities are currently some of the most disliked stocks in the world. A recent survey by Bank of America Merrill Lynch, which asked 174 respondents that together manage $513 billion in assets, about their investment allocations found that a net 27% of respondents hold and an underweight position in U.K. equities.
Mass exodus
These fund managers are not the only ones that have been selling U.K. stocks over the past 12 months. Recent data show that as much as $20.6 billion has flowed out of U.K. equity funds since the country voted to leave the European Union in 2016. According to the Financial Times, a survey by one of the U.K.'s largest wealth managers found that 35% of financial advisors have helped their clients move assets out of the U.K. in 2018.
There are two primary reasons why investors are currently avoiding the U.K. First of all, Brexit related uncertainty when the country leaves the European Union at the end of March next year. There's also the political overhang. The prospect of a hard left Labour government led by Jeremy Corbyn has tarnished the appeal of U.K. equity funds.
However, recent selling has pushed the valuation of U.K. equities down to what can only be called discount levels. Data show that the U.K. market as a whole is currently trading at a price-earnings multiple of 12, down from 14.5 times at the beginning of the year and less than the price-earnings ratio of 13 attached to the FTSE Europe ex-UK index.
I think it is difficult to justify this evaluation gap between the U.K. and Europe. Yes, there is a cloud of uncertainty hanging over the U.K. as it leaves the European Union. However, the country's economy is still growing; it has one of the world's prominent financial centers in London, sovereign debt is falling, it has its own free-floating currency and flexible labor laws unlike the vast majority of Europe. Most European countries are drowning under debt and are tied to the euro, which they cannot devalue as well as having strict labor laws that discourage employment.
Another thing to consider about the U.K. is that this is an extremely globalized economy. More than two-thirds of FTSE 100 profits come from outside the U.K. So, it makes little sense to avoid these international companies just because the outlook for the U.K. economy is deteriorating. Many of these companies report earnings in dollars but trade in pound sterling, so a weaker currency is good news for shareholders as it translates into higher earnings per share.
U.K. equities also have some of the highest dividends in the world. The dividend yield of the FTSE All Share currently stands at 4.2%, a level that has only been breached once in the past 25 years.
A better buy for value
Of course, at this point, there is every chance that U.K. equities could become cheaper if the country's outlook deteriorates further. With this being the case, buying single stocks might not be the best course of action.
Nevertheless, U.K. stock indexes look cheap right now, and the above-average dividend yield sweetens the deal. I would not rather invest in the U.K. than in Italy or Greece, both of which have been bouncing around the edge of bankruptcy now for decades and show no sign of instigating the kind of reforms that would be required to bring these economies up-to-date.
Both countries are also limited in what they can do because they are tied to the euro currency and rules of the European Central Bank. Some interesting food for thought if you are scouring the world for contrarian value.
Disclosure: The author owns no share mentioned.
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