Is now the ideal time to invest in the UK?

With Brexit 'done' and the UK economy returning to 'some sense of normality', investors are taking note

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What a difference an election win makes. Before British Prime Minister Boris Johnson’s conclusive victory in the country's general election on December 12, the UK was in stagnation mode.

Politics had gummed up, the economy was slowing, Brexit was dragging on and the country was torn in two. That changed the moment Mr Johnson won his 80-seat majority, giving him a clear mandate to crack on and “Get Brexit done”, to quote his campaign slogan.

After grinding to a halt in the final months of 2019, the UK economy is showing fresh signs of life.

From that moment, the UK was definitely leaving the EU, and it was not heading for a hard-left Labour Government led by Jeremy Corbyn.

While not every voter was delighted by the result, there was widespread relief the country did at least have clarity, and three-and-a-half years of wrangling over its relationship with the EU was over.

The pound soared in the immediate aftermath, then fell back, after Mr Johnson ruled out any extension to the transition period, when the UK will remain in the EU customs union and single market.

He says it will not be extended beyond December 31, setting a tight deadline for trade negotiations, which many believe cannot be met and reviving fears that the UK could still leave without striking a deal.

Despite that, global investors are sitting up and taking note. The UK stock market has lagged global indices due to Brexit uncertainties, but now could be set to play catch up. So is this the perfect time to invest?

After grinding to a halt in the final months of 2019, the UK economy is showing fresh signs of life.

Joshua Mahony, senior market analyst at online trading platform IG, says recent data is notably more positive, with retail sales climbing 0.9 per cent, the highest monthly growth figures for 10 months, with clothes and footwear sales up 3.9 per cent, as newly confident consumers started updating their wardrobes.

The manufacturing and services sector also both expanded, after contracting sharply at the end of last year, he notes. “The UK economy is returning to some sense of normality, with GDP expected to grow 0.2 per cent in the first three months of 2020," says Mr Mahoney.

Employment rose by 180,000 to a record high of 32.93 million, while consumer price inflation spiked in January, from 1.3 per cent to 1.8 per cent, making it less likely the Bank of England will cut interest rates from 0.75 per cent.

Confidence is back but before rushing off to buy UK shares, it may be worth heeding a few cautious voices.

Paul Danis, multi-asset portfolio strategist at wealth manager Brewin Dolphin, warns that the EU has an incentive to make leaving the union appear undesirable. “It will be a tough negotiator and demand difficult trade-offs from the UK,” he says.

Mr Johnson’s government has ruled out regulatory alignment with Brussels. “Leaving with no deal and reverting to World Trade Organisation terms remains a possibility, causing considerable uncertainty for businesses,” Mr Danis adds.

Steen Jakobsen, chief economist and chief investment officer at Saxo Bank, is also cautious, noting that the bank’s Credit Impulse data, which measures the flow of credit into the UK economy, has been negative for nine consecutive quarters.

This could hit growth and force the BoE to cut interest rates by the summer, hammering the pound.

Sterling has climbed almost 4 per cent against the euro over the past year, and more than 6 per cent against the Australian and New Zealand dollars. It is broadly flat against the US dollar, trading at about $1.29 at time of writing, but Mr Jakobsen says it could fall as low as $1.20 over the summer. “Although at that level, it would be a buying opportunity," he adds.

Mr Jakobsen believes the time to invest in the UK is after the BoE cuts interest rates, not before. “The UK has a small, open economy, with a flexible, educated workforce. It is only a few quarters away from being a screaming buy, but the time is not yet,” he says.

Gaurav Kashyap, head of futures at Equity Global Markets in Dubai, also predicts a tough summer for the pound, with BoE governor Mark Carney recently downgrading this year’s growth protections, from 1.2 per cent to just 0.8 per cent. He also expects a return of uncertainty around Brexit.

“June is the last month Britain can request an extension of its transit period beyond 2020 and this should be when it moves back into investors’ minds," he says.

He reckons sterling could fall to around $1.25, but says if it does, that could be a good time to buy UK assets. “Any sterling upside will be capped at $1.33 this year," Mr Kashyap adds.

New UK chancellor Rishi Sunak will deliver his first budget on March 11, which many expect to reverse years of austerity by borrowing and spending more, to boost the economy.

UK businesses should also benefit from reforms aiming at cutting red tape and boosting efficiency, says Vijay Valecha, chief investment officer at Century Financial in Dubai. "This should trigger a rally in UK-focused stocks, as British firms hire at the fastest pace in the year," he adds.

The simplest way to invest is to buy a low-cost exchange traded fund (ETF) tracking the FTSE 100 index of blue-chip stocks, such as iShares Core FTSE 100 UCITS (ISF) or the Vanguard FTSE 100 UCITS ETF (VUKE).

However, Mr Valecha says this may not be the best way to play the current recovery, because companies on the FTSE 100 actually generate three quarters of their earnings overseas.

When the pound strengthens, as it has lately, this makes their foreign earnings worth less once converted back into sterling.

“The FTSE 250 index medium-sized companies is more correlated to the UK economy," says Mr Valecha.

The FTSE 250 has also outperformed, delivering a total return of 48.9 per cent over past five years, against 32.3 per cent for the FTSE 100, according to figures from FTSE Russell.

You can invest in it through the iShares Core FTSE 250 UCITS (MIDD) or the Vanguard FTSE 250 UCITS ETF (VMID).

Alternatively, you can target smaller UK companies, which are typically more volatile in the short run, but can be more rewarding over the longer term.

Over the last five years, the FTSE SmallCap index has returned a total of 55.2 per cent.

Options include iShares MSCI UK Small Cap UCITS ETF (CUKS) or a successful actively-managed fund, such as Liontrust UK Smaller Companies, which is up an impressive 124 per cent over five years. Also try Standard Life UK Smaller Companies Trust, which returned 140 per cent.

The long-term outlook for UK shares hinges on who you believe, says Rupert Thompson, chief investment officer at Kingswood — the downbeat BoE or the overly optimistic Mr Johnson. “Boris believes a rosy outlook beckons, once we are unshackled from EU regulations and are benefiting from a sizeable fiscal stimulus," says Mr Thompson.

He anticipates a recovery in growth and says UK equities look cheap right now but thinks Mr Johnson may be too optimistic. “We are sceptical that the UK’s prospects will be transformed in the way the Prime Minister would have us believe," Mr Thompson adds.

The UK is now attempting something unprecedented, as no other country has left the EU before. Investing is tempting as the economy grows, but success is far from guaranteed.