It seems that interest in investing in UK shares has lost quite a bit of credibility these days. With the country facing high inflation, a growing energy crisis, a drop in economic growth and now a change in leadership in the country, investors have dumped the pound and bonos from United Kingdom. But with every crisis, there are opportunities to make money. And this one is no different...
Why are investors worried about the UK?
1. The UK economy is not going through its best moment.
With everything the UK economy is facing, next year won't be easy. That is why investors have been skeptical of a £100.000bn plan ($115.000 billion), introduced by its new prime minister, Liz Truss, to steer the economy through the economic crisis. They know that higher public spending tends to lead to higher inflation, and that is something the UK could do without. Inflation already exceeds 10% and is damaging the country's economy. And with Russia's war in Ukraine causing further increases in food and fuel prices, inflation is expected to only rise this winter. So a big government spending package could push prices up even further, possibly as much as 22% next year, according to investment bank Goldman Sachs.
UK CPI Growth Growth Forecast. Source: This is Money.
2. The pound is losing credibility.
Economists now agree that the UK is heading towards stagflation, a dismal and prolonged period of slow or negative growth and high inflation. And although none of this is pretty, everything seems to reach the markets. In August, UK 10-year bonds saw the biggest rise in yields since the late 1980s. And sterling also fell sharply, down 4,5% against the US dollar. It is the worst result among the major currencies of the “G10” industrialized economies.
Evolution of the pound sterling and the British public debt index in August. Source: Bloomberg.
The weakness of the pound makes matters worse. The United Kingdom has a "current account deficit", that is, it imports more products than it exports, and a weaker currency makes its imports more expensive, which further fuels inflation and can serve to drive down the pound even further. increase the trade deficit. In the worst case, it could even fall another 30%, according to Deutsche Bank.
How do we take advantage of this equity investment opportunity?
There is an old market saying that those who invest in bonds are smarter than those who invest in stocks. Not everyone agrees with that, but the thing is, when they change their mind, that's when we should pay attention. And that huge selling pressure in August on both sterling and UK bonds may have been one of those moments. If you think bond investors could be plotting a move in the UK economy, we could take advantage of this situation with four moves for our portfolio:
1. Sterling debacle.
Investors are increasingly convinced that the pound will trade at par with the US dollar, possibly as early as next year. We could consider selling the pound and buying the dollar, a move we can make on margin through our broker. We could also buy the ETF WisdomTree Long USD Short GBP (GBUS).
2. Buy the FTSE 100 and sell the FTSE 250.
The UK economy is under pressure, but the large-cap-focused FTSE 100 is actually one of the best-performing indices so far this year. This is because many of its companies have large overseas investments and revenues in US dollars, so the weakness of the British pound helps their profits. Meanwhile, the FTSE 250, focused on medium-sized companies and more exposed to the British economy, has suffered losses. If you think this trend will continue, we can buy the Vanguard FTSE 100 ETF (VUKE), and sell the Vanguard FTSE 250 ETF (VMID).
3. Buy Shell shares.
If you want to gain exposure to oil and gas, Shell (SHEL LN), the largest company in the FTSE 100, is the best option for your share investment portfolio. It has a price-earnings ratio (PE) of 5 times, compared to the index's average price-earnings ratio of 9 times. Although its dividend yield is only 3,5%, the company rewards its shareholders with share buybacks. Strong profits and free cash flow generation make growth from its current £6.000bn ($7.000bn) buyback likely. Shell is also listed in the US and trades in dollars (SHEL US).
4. Investment in stocks in the consumer discretionary sector.
This may seem contradictory but it is not so. Consumer discretionary spending is, clearly, what comes after paying for the essentials, the "necessaries", such as heat, rent or food. Restaurants and bakeries fall into that “soft” discretionary spending category. In addition, bakeries and pizzerias have to use their ovens (they consume gas and electricity for much of the day). It is not surprising, therefore, that its share prices have been falling as a result of the energy crisis and the rise in the cost of living. But on Tuesday, that began to change as details of a new stimulus package began to emerge. It is expected to include support for businesses and households, suggesting the worst may be over for the consumer discretionary sector. Then, we can choose to make an investment in shares of Restaurant Group (RTN LN) or the bakery chain greggs, (GRG LN), or of Domino's Pizza (SUN LN), the British franchise of the American Domino's Pizza.