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UK'S LAGGARDS EYE LIFELINE ON HOPES OF FISCAL RESET

UK's domestic equities have been punished by high gilt yields and political risk premia, but evidence of fiscal discipline from a potential Andy Burnham-led administration could give rate-sensitive laggards such as homebuilders, real estate and retail some relief.

So far this year, real estate .FTUB3510 down 4.5%, household goods and home construction .FTNMX402020 down 29%, and retailers .FTNMX404010 down 0.3%.

Prime Minister Keir Starmer's recent resignation has added to political uncertainty but Barclays notes Burnham could potentially become the new Prime Minister without any leadership contest, which reduces near-term uncertainty around UK assets.

"Market will still need confirmation of the policy agenda, the line-up of cabinet (especially the new Chancellor, etc), among other things, and the Autumn budget will be crucial for investors to assess matters," Barclays said in a note.

"However, Burnham's previous indication that he plans to operate within the existing fiscal framework should be seen as incrementally reassuring, in particular for gilt markets and consequently domestic rate-sensitive equities."

Nearly a decade after Brexit, Britain's equity market reflects a "structurally impaired" investment case, riddled by supply and demand shortfalls alike, Barclays said.

The domestically-focused FTSE 250 index .FTMC is up around 2% this year, underperforming the more internationally-focused FTSE 100 .FTSE. The midcap index is set for its smallest annual gain since 2014.

IPO activity has waned, domestic ownership of UK equities has fallen sharply, and retail participation remains low. Britain's muted presence in the global tech race has also left it lagging behind peers in the United States and Asia.

At the same time, the UK's heavy energy and commodities tilt may become less supportive.

Barclays says UK equities are expected to deliver strong earnings growth this year, but almost two-thirds of that growth is expected to come from energy and commodities. With oil prices falling after the U.S.-Iran deal, that tailwind could fade.

Still, Barclays argues that depressed UK valuations create selective opportunities.

Despite its "underweight" stance on UK overall it sees scope for relief in domestic rate-sensitive laggards if fiscal credibility improves.

UK's lack of tech exposure and defensive tilt could make it useful as a diversification tool or anti-momentum hedge in global portfolios, especially if AI and technology trades pull back, Barclays said.

(Kanchana Chakravarty)

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