After years of enduring a bleak outlook for Britain’s economy, investors are detecting a glimmer of hope, with some prominent players in the financial world suggesting that the era of extreme pessimism may be drawing to a close. This newfound optimism is expected to usher in gains for UK-focused businesses and the previously overlooked FTSE 100.
The UK’s FTSE All Share index, now valued at approximately £2.28 trillion ($2.84 trillion), has endured years of outflows, leading to major companies like materials group CRH shifting their stock listings overseas. This valuation is now nearly on par with that of a single U.S. giant, Apple, while British firms find themselves trading at an all-time discount relative to global equities.
Factors such as high government debt, deteriorating infrastructure, political instability, and 14 interest rate hikes since late 2021 have severely impacted investor sentiment.
Despite fluctuating UK growth data attributed to unfavorable weather conditions and labor strikes, the economy has thus far managed to avoid the dreaded recession. Official statistics have even indicated that the UK recovered from the COVID-19 pandemic sooner than initially believed.
UK-based investors are demonstrating their renewed faith by increasing holdings in domestic businesses and seizing opportunities presented by the undervalued FTSE-100.
Daniel Lockyer, Senior Fund Manager at Hawksmoor Investment Management, which oversees assets totaling £7 billion, remarked, “It feels like we’ve passed the peak of pessimism about the UK. We don’t necessarily require an influx of positive news, but the trend of negativity is slowing, and seizing the opportunity at the market’s nadir is key to successful investing.”
Nonetheless, the exodus from UK equity funds has been substantial, with a cumulative £76 billion leaving the market since 2016, as per data from Morningstar. Over the same period, global equity funds have seen net inflows of £507 billion.
In pursuit of better returns abroad, UK pension funds have sharply reduced their allocations to UK equities from 53% to just 6% over the past 25 years, according to think tank New Financial.
However, there are pockets of resilience within the UK market. While the FTSE 250, which caters to domestic businesses, has experienced declines in four out of the last six months, the FTSE 350 sub-index, focusing on leisure stocks, has surged by 18% year-to-date. A dedicated UK retail stocks index has also recorded a 23% gain.
Investors are favoring consumer stocks in anticipation of the UK’s cost-of-living crisis easing.
“Invesco’s Head of UK Equities, Martin Walker, pointed out that the UK economy’s performance will exceed market expectations,” and he is now slightly overweight in UK consumer staples for the first time in years.
The FTSE 100, currently trading at a price-earnings ratio of 10.5 times compared to the wider Stoxx Europe 600’s 12.5 times, is regarded as a prime opportunity due to its discounted valuations.
Economists polled by Reuters predict the UK will eke out 0.3% growth this year, trailing behind the eurozone but a far cry from the recession that was predicted for late 2022.
Nonetheless, the Bank of England is expected to raise interest rates again this month, which could add to the financial strain for homeowners dealing with the refinancing of fixed-term mortgages at higher rates.
On the bright side, wages are now growing faster than prices after UK households faced their most significant inflation shock in four decades and a cost-of-living crisis. Energy bills are expected to decline to a two-year low next month.
Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics, pointed out that pay increases mean British households can “maintain their current level of real expenditure under any plausible scenario for official interest rates.”
Investors like Leigh Himsworth, UK Fund Manager at Fidelity International, are actively seeking opportunities in UK retailers and the real estate sector.
Neil Birrell, Chief Investment Officer at Premier Miton, has increased the proportion of UK stocks in his multi-asset portfolios to the highest level since 2019, with a focus on consumer-oriented businesses.
While there are compelling economic reasons to anticipate a turnaround for UK stocks, fund managers are calling for further measures from policymakers to reignite interest in British equities.
Premier Miton is lobbying for the introduction of a new tax-efficient investment vehicle for UK stocks, while Himsworth at Fidelity suggests the creation of a new national savings product to provide capital to British businesses.
Savvas Savouri, Partner and Chief Economist at hedge fund Toscafund, believes that high-quality UK companies lack a strong domestic investor base and that the country’s equities have underperformed. He states, “UK equities have been an abject failure because we don’t value our companies.”
($1 = £0.7990)
