Are things finally looking up for UK equities?

I hate to tempt providence, but have you seen how the UK stock market has been performing lately? While the US, Japan, Asia and Europe are all in negative territory year to date, the FTSE 100 is up. “UK large caps have been starting to outperform in recent weeks,” said Simon Brazier, manager of Ninety One UK Alpha.

So could things finally be looking up for our beleaguered home market?

UK companies have been unloved for years

The FTSE 100 in particular has been shunned over the last ten years for three key reasons,” said Hugh Sergeant, manager of ES R&M UK Recovery. “It’s been seen as too value oriented in a world that favoured growth stocks; too skewed towards important but slower-growing industries such as banking, energy and healthcare; and too risky due to Brexit.

“As a result, UK equities have become very cheap relative to the rest of the world – they have been trading on the biggest discount to global equities since the mid 70’s period when the UK was almost bust.”

Indeed, as the chart show below, UK equities were trading on about a 40% discount to global peers towards the end of last year.


Cheap, but not attractive

But unfortunately, being cheap hasn’t been enough to attract investors to our home market – outflows from the sector have continued.

As Henry Dixon, manager of Man GLG Income pointed out last week, 2021 saw more money flow into global equities than in the past 20 years cumulatively, but the UK still suffered outflows.

What’s more, UK defined benefit pension fund asset allocation to UK equities has fallen from more than 50% in 1996 to single digits in 2020. “There is almost nothing left to sell,” Henry said.

The only people buying UK equities has been private equity investors through M&A activity.

But could things be about to change?

The UK market is likely to outperform if inflation persists – which is an increasing possibility. Our stock market has a lot of exposure to old economy stocks such as oil, mining and banks and less exposure to tech (which has been part of the problem in recent years).

The global move to electrification should help our large, diversified miners. High oil and commodity prices are also likely to benefit large parts of the UK market, and higher interest rates could also help the banking sector. 

The simple fact that the UK has started to outperform again may force international investors to sit up and take notice.

Alex Savvides, manager of JOHCM UK Dynamic, pointed out that there has been a major regime shift across global asset markets year to date with sectors which are already well-allocated to (the US, tech, growth, ESG) underperforming.

Instead, the laggards of the last decade (value, financials and commodities), have become the new leaders.

This can be seen in the performance of the major indices – the value orientated markets have performed the best with the UK currently in first place. The US, and within that, the Nasdaq, have materially underperformed.

Regional performance YTD – value countries up, growth countries down

Image 2

Source: MSCI, Datastream, Barclays Research, JO Hamro Capital Management Group, 25 January 2022

There were three main catalysts for this rotation, according to Alex:

  • Clear evidence that inflation is not transitory
  • The resultant change in messaging from the US central bank (QE being withdrawn earlier / rate rises sooner)
  • Further signs that Omicron could be the beginning of the end of the pandemic

Given that the FTSE 100 is more exposed to value stocks than the FTSE 250 or FTSE Small Cap, the disparity of performance can also be seen when the UK Indices are compared,” added Chris St John, manager of AXA Framlington UK Mid Cap.

“For example, the FTSE 100 has hit a new multi-year high, whereas the FTSE Mid and Small cap Indices both hit a high on 1 September 2021. Since then, the FTSE Small Cap is down 9%, FTSE 250 is down 12% and AIM 100 is down 20%* (as at 25 Jan 2022).

Reasons to be cheerful

Hugh Sergeant says there are number of reasons to be cheerful when it comes to the outlook for UK equities. “All the negatives are becoming positive,” he said.

“Value is at a multi-generational low point and there are huge opportunities to be taken in this area as investors re-discover the benefits of paying a sensible price for a stream of profits and cash flow. Added to this, many recovery stocks are yet to see share price recovery, small caps have lagged badly recently, and many beneficiaries of the reopening of the economy are back to relative lows.

“The business mix of the FTSE 100 is attractive again so that big global leaders with strong cash flow generation and profits are a positive. And with inflation and cost of living rises at the forefront of many minds and an ensuant interest rise announced only last week, the inflation hedge credentials of some of our biggest companies such as banks and commodity producers are additional positives.”
And let’s not forget that some of our more quality growth companies are now a lot cheaper than they were, possibly making for good entry points.

For example, Lesley Dunn, manager of ASI UK Ethical Equity pointed out: “Recently, the software sector has experienced a de-rating as inflation and interest rate expectations continue to influence the sector.

However, over our longer term investment time horizon there are a number of interesting companies at currently attractive valuations. Companies like SoftCat, which is the UK’s leading technology reseller, supporting the hardware and software technology requirements of nearly 10,000 enterprise, SME and public sector customers in the UK.
Simon Brazier is also of this opinion and is “doubling down” on opportunities in quality companies that have more attractive valuations today.

*Source: AXA Investment Management, 25 January 2022

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 do not constitute financial advice.

Published on 11/02/2022