Equity, UK and EM go hand in hand

Theresa May’s statements have sent the pound sterling even lower, a few days ago.

Weaker pound supportive of UK equities
A weaker currency does however not have to be negative. Financial conditions in the UK are supported by the rapid depreciation of the pound. This is a crucial element for the UK equity market, as it consists mainly of large multinational companies which realise the chunk of their revenues overseas. A weaker pound thus boosts UK companies’ competitiveness. This is one of the reasons why we have a positive view on UK equities. Other reasons are the supportive policy mix, as the Bank of England is pursuing an accommodative monetary policy which is expected to be joined by a more supportive fiscal policy stance as well. The fact that economic data have held up well is also supportive. Furthermore, the UK market is sensitive to the performance of emerging markets. This relation can be explained by the relatively large presence of the commodity sector in the UK and by the Asian exposure of the UK banking sector.

Emerging markets can keep performing well
Together with the FTSE 100 in the UK, emerging market (EM) equities are the best performing region this year (in local currency). EM equities continue to benefit from a strong search for yield. Investment flows into EM equities have been positive for most of this year and are likely to remain strong, helped by ongoing easy monetary policy in developed markets (DM) and the resulting easing of EM financial conditions. Despite some nervousness around the September meeting of the Federal Reserve, expectations for Fed policy action have not moved that much in the past few months. More importantly, markets continue to believe that the normalization of US interest rates will remain a very slow process in the coming years. As long as Fed expectations do not change much and EM fundamentals on balance do not deteriorate, we should expect flows to EM assets to remain positive.

Moreover, EM earnings momentum has been rising steadily and turned positive for the first time in two years. Meanwhile EM equities still trade at a significant discount relative to DM equities. Other support factors are higher commodity prices, although this link may be weaker than in the past. Positive in this respect are the latest data from China, where particularly strong real estate figures offer support to the construction market outlook and therefore industrial commodity prices. The rise in the oil price following the (provisional) OPEC deal is also supportive.

Valentijn van Nieuwenhuijzen – Chief Strategist and Head of Multi Asset – NN Investment Partners