The final quarter of 2020 saw strong returns for equity sectors, whatever their location, but the big winners in this vaccine rally have been UK stocks. Equity UK returned 14.8% for the quarter, and Equity UK Small & Mid Cap was the top Lipper Global Classification over the same period, returning 21.1%.
That, of course, needs to be taken in the context of their longer-term performance. Equity UK was down by 7.3% over the year—one of the worst performing major equity classifications. Equity UK Small & Mid Cap did better, benefiting from broader small cap tailwinds, with a positive 2020 return of 4.4%, but still lacklustre in comparison to other small cap sectors.
Source: Refinitiv Lipper
By way of comparison, Equity Eurozone was up 11.4% over the year and Equity US returned 18.7%. But come October, all this got thrown into reverse—literally, as the UK and US swapped positions at the top and bottom of the table. The questions are, what is driving this, and is it sustainable?
Not Talking About Brexit
The first thing to lay to rest is that it isn’t Brexit. For a start, there was nothing happening in Q4 regarding the trade negotiations that could trigger this rotation. Indeed, as we got bogged further down in eleventh-hour negotiations, the only clarity seemed to be on what was on the menu for Boris Johnson and Ursula von der Leyen, rather than what was going to be served up to the rest of us within the ensuing weeks. Interpret events from 1 January as you will, but EU/UK developments (or their lack) in early Q4 were beyond doubt a headwind for UK equities.
What did benefit the UK market was not the gift of any politician to give. Immunologists, perhaps, but not politicians. From late October, the long run of growth stocks was reversed, and value rallied as news of success in vaccine development broke. Indeed, the last week that the Russell 1000 Value index outperformed its growth peer was during the dotcom bubble of 2000. The US market’s performance has been driven by a large weighting to new economy stocks, and it is this same characteristic that produced the ‘and the first shall be last’ effect in Table 1.
UK equity indices have a value bias, with overweights to sectors such as Financials and Energy, which rallied strongly at the same time.
The rotation is well illustrated by the change in leadership between the full year 2020 and Q4. Another striking factor is that, while the top five funds over Q4 had all returned more than a third, they were still down over the year, indicating just how badly they had fared during the first three quarters.
In With the Old
Leading portfolios over the year are characterised by large allocations to Information Technology and Consumer Discretionary; Q4 leaders, Financials and Industrials.
Can the good times continue to roll for UK equities? Refinitiv analysis indicates strong 2021 year-on-year earnings growth for the FTSE 350, not least for cyclical sectors including Industrials Energy and Consumer Discretionary, in contrast to Technology, with one of the lowest. There are, however, far too many wild cards at play in global markets, and while fundamental investors will (by definition) yearn for a return to fundamentals, it’s been a long time coming so far.
Thus far, it looks like this good news hasn’t won investors over: in fact, quite the reverse. While Equity UK netted £5.3bn last year, positive flows were confined entirely to the first half of the year. Q3, directly before the rally, saw outflows of £1.16bn, and Q4 of £777m.
