Is the UK now a bargain? Analysts weigh in after market meltdown

UK bond markets and the pound plummeted this week as investors shrugged off the new government’s fiscal policy announcements and some analysts believe opportunities are emerging.

The Bank of England was forced to intervene in the bond market on Wednesday with a temporary buying program as the capitulation of long-held gold prices threatened pension funds and mortgages, posing what the central bank considered a significant risk to financial stability.

British bond yields are on course for their sharpest monthly rise since at least 1[ads1]957, while the pound fell to a record low against the dollar on Monday.

Viraj Patel, senior strategist at Vanda Research, told CNBC on Wednesday ahead of the announcement that the next few weeks will be critical for investors to consider whether to return to UK markets, but he would not weigh in just yet.

“The pound six days ago was not an issue for me. I was looking at a number of other currencies as more displaced in the markets right now,” Patel said.

He added that the fall in the currency and UK bonds represented a vote of no confidence in the government’s fiscal package, and concerns about where sustainable growth will come from in an environment of high and rising short-term interest rates.

“I think some of these doomsday fears are being exaggerated to some extent, but I don’t think anyone wants to go in right now and buy undervalued UK assets at this time,” he said.

“We could have another conversation in three months because the pound is extremely cheap, but I think it’s just one of those things where there’s the storm before the calm.”

The UK stock market has also sold off in recent sessions, but no more deeply than other markets across Europe, amid a broad global decline in stocks, as fears of more aggressive monetary policy tightening by central banks and slowing growth force investors to the sidelines. .

Alan Custis, head of UK equities at Lazard Asset Management, told CNBC on Thursday that the general sell-off as a result of the country’s economic turmoil “kind of throws up some opportunities” for UK blue chips with overseas earnings benefiting from a fall. pound.

Equity analysts are keeping a close eye on the gilts

British long-dated bonds – known as “gilts” – have seen historic levels of volatility in recent days, with prices rebounding from the initial collapse on the back of the Bank of England’s announcement that it would buy long-dated bonds for two weeks and postpone next week’s planned gold sales until 31 October.

Custis said equity analysts were closely watching volatility in gold markets for indications of where interest rates are likely to go.

“The market is now discounting interest rates going up to 6%. Before this situation last week, we thought probably 3.75, maybe 3.5% would be the peak, inflation maybe peaking in October or November this year at around 11%. Now clear, which has been thrown out, because we don’t know where the pound is going to go, how inflationary a weak pound can be for the economy,” Custis said.

“Stability in the gilt market is very important for these reasons, because it can give us some sense of where interest rates may eventually land, and obviously that will have a big impact on mortgage rates and consumer spending, so it’s all connected, so yes, we look at the gold market as much as we look at the stock market.”

Britain’s blue-chip FTSE 100 is known for its high dividend yields for investors, but with rising bond yields the attractiveness of this type of stock is diminishing, Custis acknowledged, but he highlighted that 45% of dividends paid by companies on the index. is paid in dollars, which insulates it to some extent.

This would also help explain why Britain’s mid-cap FTSE 250 index has had a tougher run in light of the country’s economic chaos and currency collapse than its large-cap cousin.

“As we saw with the real estate companies in the first couple of days of this week, the (capitalization) interest rates in real estate stocks are four and a half percent – if you have interest rates at 6%, it’s very difficult for real estate stocks to look attractive. “

Central to the near-term outlook, analysts have suggested, is for Finance Minister Kwasi Kwarteng to restore credibility, having taken the rare step of omitting forecasts from Britain’s independent Office for Budget Responsibility ahead of Friday’s controversial announcements.

Kwarteng has promised a more detailed and costed implementation plan on November 23, while the Bank of England meets on November 3 to assess the impact of the fiscal announcements and determine the scale of the next rate hike.

“I think we need to see the OBR, the Bank of England and the Chancellor come together and re-enforce the economic prudence, the driving lanes, the target of reducing the debt-to-GDP figure – although we are in quite a strong position at the moment,” Custis said, adding that a joint statement in November would be a positive signal for markets.

Although some analysts have highlighted Britain retaining strong fiscal fundamentals and supporting barriers to bonds and the currency, many are reluctant to jump back in until the smoke clears.

Seema Shah, senior global investment strategist at Principal Global Investors, said investors were assessing whether the UK remains an attractive long-term investment destination alongside other developed economies.

“Whereas for the U.S., I think it’s a resounding yes over the next 10 years — stocks will be higher than where they are today,” she told CNBC on Wednesday.

“For the UK it’s probably a bigger question of how much higher are they going to be and do we really believe in the UK going forward as a place we want to put our money?”