Four bargain markets this ISA season, March 2023

ISA season is here once again! If you are still looking for a tax-free home to use up last year’s allowance, or a place to stash cash from your new allowance from 6th April, you could do a lot worse than our pick of four markets currently offering cheaper than usual valuations. Everyone loves a bargain, and there are plenty to be had in the UK, European Smaller Companies, China, and Japan.

First up, the UK 

The UK market has been on fire sale since the decision to leave the EU in 2016. It has been in deep value territory and is now ripe for investors to take advantage of the low valuation. Challenging markets in 2022 led to the largest disparity in terms of performance between the FTSE 100 and FTSE 250, with the latter 25% worse off over during the period*. This, says Ketan Patel, fund manager of the EdenTree Responsible and Sustainable UK Equity fund, has left several high quality businesses mis-priced, and the prospect of strong long-term returns.

“For long-term investors the UK market offers a low valuation coupled with high dividends, ideal for those who want to use the power of compounding income in a tax-free ISA wrapper,” he said. “A basket of names in the banking and insurance sector offer a yield in excess of 7%”, he pointed out. “And dividends matter – over 50% of total returns come from dividends and closer to 90% if the income is reinvested. With the cost of living crisis, generating income from investments could play a key role in navigating the current high inflation environment,” Ketan said.

Next, European smaller companies

With war and an energy crisis triggering steep falls last year, European smaller companies remain cheap. They have outperformed so far in 2023, due a milder winter alleviating gas supply fears, and the easing of supply chain pressures leading to inventory restocking, in support of European cyclicals. Add in an inexpensive currency and government spending on infrastructure, and you have an ideal environment for European small caps.

Confident in the region, the abrdn Global Smaller Companies fund is overweight Europe. Since the start of the year, manager Kirsty Desson has topped up its exposure to high quality cyclical stocks where earnings, valuations, and, most importantly, management commentary have been supportive of the outlook.

Looking ahead, Kirsty says that “The European small cap benchmark has a higher weighting of economically sensitive sectors, like industrials and financials, than the global small cap index, so closely reflects expected improvements in capital expenditure and economic growth.” Plus, historically, small caps far outperform large caps during recovery periods, like now, “Outperformance that is sustained for three years or more from the bottom of the cycle,” concluded Kirsty.

Then there’s China 

Chinese stocks have rebounded from the ultra-low levels reached in October last year, yet they still trade below their own 20-year averages and below those of the region**.

Edmund Harriss, co-manager of the Guinness Asian Equity Income fund, pointed out that while in the US the Fed is battling to bring inflation under control and slow growth, by contrast, China is working to re-accelerate economic growth after the years of pandemic lockdowns. “As a result the World Bank sees China as the economic bright spot with a growth forecast of 4.3%,” said Edmund. “Private sector forecasts put it even higher at 5% to 7%. This is reflected in market analysts’ forecasts of earnings growth of almost 17% a year over the next two years, which compares to forecasts of 7% a year (and falling) for developed markets.”

For investors, above average earnings growth coupled with below average valuations provide an opportunity. The Guinness Asian Equity Income Fund has identified long-term structural growth themes in urbanisation, household wealth, consumer spending, financial sector development, healthcare, and industrial specialisation, which the manager thinks will make delivery of this growth to investors more certain.

And finally, Japan 

Often put in the unflatteringly titled ‘cheap for a reason’ box, for any investor who invests based on the macroeconomic outlook the question is usually, “why should I bother with Japan?” This, says, Sophia Li, co-manager of the FSSA Japan Focus fund, is entirely the wrong question for this year’s crop of bargain-hunting ISA investors.

While many foreign investors sold virtually all their Japan equity holdings accumulated from the beginning of the Abenomics story in 2012, Japan’s corporate profits have continued to grow to record-high levels, driven by global expansion, innovative products, and the development of new technologies. Corporate restructurings and an increasing focus on return on invested capital have also contributed to higher profits.

Sophia pointed out that in each sector, the gap between the winners and the losers is widening. “As a result, we believe that an active and bottom-up investment strategy in Japan equities would work well for investors in the UK,” she says.

*Source: FE fundinfo, total returns in sterling, FTSE 100 and FTSE 250, 23 June 2016 to 6 March 2023
**Source: Guinness Global Investors

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.