ANALYSIS: UK Stocks Poised to Benefit as Equity Rally Wanes, According to Reuters

UK Stocks Poised for Defensive Recovery

• UK shares expected to benefit from their defensive character and a potential economic rebound
• Britain anticipated to recover more quickly than continental Europe
• Investors turning to UK markets as stock rally reaches its peak

By Simon Falush

LONDON, June 4 – British equities are likely to gain from their defensive nature once the current stock market surge cools down, marking a shift from the recent outperformance of more cyclical stocks in continental Europe.

Since hitting a six-year low on March 9, Britain’s FTSE 100 has climbed 26 percent. However, this increase lags behind the pan-European FTSEurofirst 300, which has risen by 35 percent, and Germany’s DAX, which has jumped 42 percent.

As long as the rally persists, the FTSE 100’s substantial allocation in defensive sectors—such as pharmaceuticals and tobacco—along with a scarcity of cyclical industrials, will keep it trailing behind its European counterparts.

Experts caution that the current upward trend lacks a solid foundation.

“The recent surge seems driven more by optimism than by tangible results. Confidence has shifted from despair to mere disappointment,” noted Justin Urquhart-Stewart, investment director at Seven Investment Management. “We’re getting deeper into uncertain territory, and I’m concerned about the sustainability of this momentum.”

The significant quantitative easing policies from the Bank of England and the Federal Reserve are expected to facilitate an earlier and more robust recovery in the UK and the US compared to Europe, where economic revival has been slower and less decisive.

“It fundamentally comes down to the macro outlook,” explained Philip Lawlor, chief portfolio strategist at Nomura. “I still struggle to see a bright future for Europe. The European Central Bank has not kept pace, and they lack the tools for comprehensive quantitative easing.”

Europe initially gained from a surge of optimism once investors recognized that a total global economic collapse could be avoided. However, analysts predict that as recovery progresses, Europe might face more challenges.

“The market will shift towards areas where actual recovery is apparent,” Lawlor added, predicting that the UK would experience a quicker rebound than its continental neighbors.

Recent PMI data from the UK indicated an unexpected growth surge in the service sector in April, while the eurozone reported a more severe economic contraction in the first quarter than previously estimated.

Defensive vs. Cyclical Stocks

In 2008, the defensive character of the UK index allowed it to outperform during a downturn, with a 31 percent drop compared to a 40 percent plunge for the DAX. Investors are likely to gravitate back towards defensive stocks as confidence wanes.

Key defensive players in the UK market include pharmaceutical leaders GlaxoSmithKline and AstraZeneca, along with tobacco firm British American Tobacco and retail giants like Tesco.

This year, the DJ STOXX European healthcare sector has seen a 7.9 percent decline, contrasting with a 5.2 percent gain for the broader index, yet it suffered an 18.8 percent drop in 2008 while the FTSEurofirst 300 lost 40 percent.

While the stock market continues to rally, favoring continental Europe may appear appealing for now.

“Our current preference is for continental Europe,” stated Kevin Gardiner, head of Global Equity Strategy at HSBC Investment Bank. “We believe that when risk appetite returns, the more volatile markets will perform best. This suggests that, given the UK’s larger portion of defensive stocks compared to cyclical ones in Germany, continental markets may outpace the UK.”

Gardiner highlighted that industrial sector weightings in the UK are about 4-5 percent, while continental Europe’s is around 13 percent. “If investors seek exposure to companies connected to economic stability, continental Europe offers significantly more opportunities than the UK,” he added.

The catalyst for a shift back to defensive stocks and an overweight position in UK equities will be a return to data and corporate results that meet rather than exceed expectations.

“You need positive surprises for the rally to sustain,” said Ad van Tiggelen, senior strategist at ING Investment Management. “Should data align with or fall short of expectations, it could trigger a substantial correction. This may take weeks or even months to unfold.”