The leading UK share index has just done something it has only done once before since 1984 – that is, 12 closing all-time highs in any rolling one-month period. The last time this happened was in January 2017.
‘Exuberance’ and ‘UK shares’ have rarely been mentioned in the same sentence for many years now. As the chart below shows, even with dividends reinvested, the MSCI United Kingdom index (black line) has significantly underperformed the US S&P 500 (red line) over the past ten years even with dividends reinvested!
As the Pound has been so weak over this period, returns to most international investors investing in the UK have been even worse! It is easy to see why many investors have all but given up on the UK domestic equity markets. According to Schroders, the UK stock market forward Price Earnings Ratio has recently been at over a 40% discount to the US and over a 20% discount to Europe – which reflects how low sentiment is to UK shares compared to those of its international peers. Small wonder that UK companies, such as Shell, are openly exploring moving from the London exchange for a New York listing!
This begs the question – are UK markets ‘uninvestable’? In a recent Taking Stock, I explored this question with respect to Japanese and Chinese markets. The moral of the story was that there is generally always a time to buy, even in the most neglected of markets!
What makes the UK potentially attractive now?
Economic recovery:
Business surveys and economist predictions are turning increasingly positive. After a very brief recession last year, the UK has seen back-to-back increases in output over the first months of this year. The BDO Business Trends Survey, which collects and regroups data from the UK’s main business surveys, suggests UK economic output is now at its highest since May 2022. Manufacturing output has been accelerating – the Confederation of British Industry in its latest quarterly survey showed British manufacturers were at their most optimistic since July 2021.
Wages rising, inflation falling:
Inflation is falling but wage growth is still high. Data recently published by the Office for National Statistics shows pay rises, excluding bonuses, are running at 6% – which is good news because this means more money in the pockets of workers. The rise in disposable incomes bodes well for a continued economic recovery in spending in 2024. Meanwhile, UK inflation rose by 3.2% in the year to March 2024 – the lowest rate since September 2021.
Low UK stock market valuations:
Unfortunately, the UK is not blessed with a plethora of large technology companies and as a result, stocks tend to trade at a discount to international peers. However, even oil companies, such as Shell, trade at a discount to oil companies listed in the US such as Exxon – which is more of an anomaly. The CEO of Shell recently stated that the company could abandon London for a New York listing where in general, comparable companies trade at higher valuations. This has been a wake-up call for London as losing the single largest UK company would be a hammer blow to the UK stock market.
Reform:
The low valuations of UK companies and the perceived unattractive investment environment are slowly premating into political circles. UK pension funds, once significant investors in UK equity markets, have been net sellers of UK equities for many years. Having owned 40% of their assets in UK equities some 30 years ago, today this figure is less than 4%. There has now been government action, such as the so-called Mansion House Reforms, to encourage pension companies to commit a small percentage of the vast pool of their assets to invest into UK high-growth companies, including life sciences and fintech. The recently announced ‘British ISA’ proposal could also drive a significant amount of additional investment into UK companies.
Investment Trends
As noted recently by Anatole Kaletsky of Economic consultancy Gavekal, the 2010s and the aftermath of the Great Financial Crisis were not kind to many global equity markets, especially because the focus of investors and best-performing companies were relatively ‘capital light’ – social media, software and internet-based companies benefited the most. Kaletsky argues that the world is now moving towards a more ‘capital intensive’ phase of development – the push for carbon-neutrality, an increase in defence spending and reshoring are examples of higher capital intensity, requiring greater up-front investments in commodities, new technologies and supply chains. Industries, such as transport, construction and manufacturers would benefit. Arguably, the UK equity market may be well-placed with representation in other industries aside from technology.
The disappearing UK equity market:
J O Hambro recently estimated that in 2023, 5% of the UK equity market share count was reduced by share buybacks. Additionally, a small but not insignificant trickle of companies are leaving the UK for US markets – the most notable of which is Paddy Power’s owner Flutterwave which will move there this summer. Finally, UK companies are also disappearing into the hands of overseas acquirers, mainly private equity. Weirdly, in the short term, this would help the UK market as more money chases fewer shares. However, on a longer-term view, it is not a healthy development. Over the next two years, this is likely to spur significant activity to make the London equity markets more attractive.
Recently, Calastone, a company that tracks UK investor flows, said this was the best ISA season on record in nine years of data. However, the majority of investor monies went into Global or North American funds – UK investors continued to be active net sellers of their own UK domestic market! With such negativity abound over recent years, this is unsurprising.
However, there are good reasons now to believe things cannot get a great deal worse – and this is often the time to be fishing in the waters that many investors have deserted. At Raymond James, Richmond, we think we are at the stage where it is darkest before the dawn for UK equities and are increasing exposure to a much unloved area.
Risk warning: With investing, your capital is at risk. Opinions constitute our judgement as of this date and are subject to change without warning. Past performance is not a reliable indicator of future results. This article is intended for informational purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person.