Have investors got it wrong on the outlook for UK domestic-focused shares over the coming months? One expert believes so, as we now explain.

The attention on the looming UK general election on 8 June has taken some of the spotlight off the Brexit process which officially started in March. Yet Brexit will return to the forefront of politicians’ and investors’ minds when the election winner is announced on 9 June.

Further volatility in sterling seems likely given the acrimonious start to negotiations between the UK and the remaining members of the European Union. There may also be the first signs of what impact, if any, Brexit-related uncertainty is having on the UK economy.

This is very important to investors. Why? Some people argue that expectations for weak UK data have already been fully priced in to the value of domestically-focused UK shares. If true, any bad news on the economic front may only trigger a mute reaction to the domestically-focused FTSE 250 index.

However, other people believe that investors may have underestimated the impact of negative UK data (if it happens) in the future, so UK shares would still be susceptible to economic setbacks.

KEEP AN EYE ON GDP

UK GDP growth in the first quarter of 2017 was 0.3%, its slowest level since the beginning of 2016. The first GDP estimate for the second quarter should be out on 27 July; and the third quarter estimate is scheduled for 25 October.

The consensus GDP forecast for 2017 as a whole of 1.7%, compiled by the Treasury in April, implies growth will have to pick up in the remainder of the year to hit this estimate.

Last week investment bank Liberum commented: ‘One of the bull arguments for domestics in recent meetings has been that “the UK is on a 12 times price to earnings and the rest of the world is on 18 times” – a discount of around 33% – implying that the bad news coming in the second half of the year is (overly) priced in.’

Liberum suspects this quote has been backed by ‘cherry picked data’, prompting it to run various tests on the market versus US and European equities.

It concludes that the UK domestic market is only trading on a 5% to 10% discount – thus implying that potential bad news has certainly not be fully priced in.

Liberum believes domestic cyclicals – firms which are sensitive to movements in the wider UK economy – as being ‘relatively overvalued’ heading into the second half of the year when it expects a raft of below-consensus economic data. (TS)

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