JPMorgan upgrades UK equities to 'overweight'; base case is no Brexit

JPMorgan Cazenove upgraded UK equities to ‘overweight’, having held an ‘underweight’ stance on the region for three years, as it said the risk/reward has improved.

The bank noted UK equities are now trading at an outright attractive price-to-book ratio given a 30% underperformance since 2012, with earnings per share revisions improving.

In addition, it argued the UK is a high-yield, liquid market that usually performs well in a challenging global backdrop and in a falling bond yield regime.

JPM said that while high commodity exposure was a drag on the UK over the past five years, commodities’ weight has more than halved.

“We are unexcited by commodities, but believe that in 2016, commodities will not be a major source of underperformance anymore. Investors are still underweight the space, and we believe that one should be reducing shorts during the course of this year.”

The bank also said the recent rollover in the trade-weighted GBP to two-year lows is a help, as the FTSE 100 derives 72% of its revenues from abroad.

As far as ‘Brexit’ is concerned, JPM’s base case is that the UK stays in Europe, although it said this was likely to be a close call.

"In the event of the UK leaving, the initial knee-jerk impact on the market could be quite negative, but we believe the resulting GBP weakness and BoE action will cushion a chunk of the fall in equities,” it said.

The bank recommended hedging this risk by being ‘overweight’ exporters versus domestic, and FTSE 100 versus FTSE 250.

In terms of what to buy, JPM highlighted three main areas of interest: exporters, defensive yield plays such as utilities, telecoms and real estate, and domestic plays such as housebuilders and retail.

JPMorgan funded the move to OW the UK by cutting its stance on Japanese equities to ‘neutral’ saying earnings momentum is slowing down and if yen strength persists, Japanese EPS growth will be negative this year.