JP Morgan upgrades UK stocks because of their defensive qualities

Strategists at JP Morgan upgraded their recommendation on UK stocks, touting the 'defensive' qualities of British shares, expectations for better performance from commodity sectors, limited upside for sterling and record cheap valuations on some metrics.

The strategy team led by Mislav Matejka also said it expected euro area purchasing managers surveys to 'roll over' and the euro to strengthen, telling clients to favour domestic plays, like telecoms and utilities, over cyclical exporters such as autos, capital goods, technology and chemicals.

In the opinion of Matejka, the UK market's high dividend yield meant it should perform better against a backdrop of a potential softening in activity indicators, alongside lower inflation prints and range-bound bond yields.

Hence, Matejka and his team upgraded UK stocks to 'neutral' from 'underweight'.

Limited upside for the British pound should also be a tailwind for exporters on the FTSE 100, the investment bank said.

But the 'big picture' was in fact one of US dollar weakness, which should help the performance of commodity sectors, where weakness year-to-date might be an opportunity.

In terms of valuation, UK stocks were record cheap in terms of their relative price-to-book multiples, even when excluding commodities, JP Morgan said.

Due to all of the above, JP Morgan also believed exporters should start to beat domestic plays again.

"Domestic [plays] are still stretched in the historical context on price and earnings relative. Meanwhile, buying into domestic plays is not really buying a potential V-shaped recovery, given that house prices and consumer activity never fell in the first place. There is not much positive operating leverage ahead for domestic plays. On the other hand, GBP might become a tailwind for exporters. FTSE100 vs FTSE250 trade is interesting again."

In the same research note, JP Morgan's Matejka also reiterated his team's decision in early May to downgrade global Cyclicals and upgrade Defensives.

JP Morgan also added to Utilities, raising its recommendation on that segment from 'underweight' to 'neutral' at the expense of autos, which it downgraded to 'neutral'.