Ian Hewett, investment director at abrdn, discusses the resilience of the FTSE 100 relative to other indices in spite of economic uncertainty in the UK.
Whilst it is hard to draw strong conclusions from performance over a month, it does hint at some of the current attractions of the UK market.
Some investors, including UK pension funds have allocated funds away from the UK recently, leading to broadly low corporate valuations versus other markets – even for very similar companies. From this starting point then, the stage is set for a market rebound, as we have seen in part over the last month. The UK market has also been outperforming global and European benchmarks since the start of 2022.
Oil & Gas and Mining account for around 20% of the FTSE 100 Index and both rose by around 10% over the past month on the back of rising oil and commodity prices. Whilst a positive contributor to the overall index, this is not the whole story.
The direct beneficiaries account for around 20% of the index, but the UK has long been home to a range of international businesses – and many posted strong returns in the month. However, the market strength was much broader than this, with domestically exposed companies performing particularly strongly. This can be seen in the rises of UK Housebuilders and domestic banks. Here, valuations have been particularly depressed, in most cases at material discounts to book value, so good news has the potential to lead to strong equity performance. In this case, indications that the interest rate cycle may be peaking have been taken positively by the market as a sign that inflation may be reducing to more controlled levels, allowing for lower rates and a monetary environment more supportive of growth.
There are further prospects for growth. There is a widely accepted narrative that the UK economy is weak, and UK markets weak with it. The reality is, of course, much more nuanced. Notably in recent weeks, UK GDP has been revised upwards, inflation is falling rapidly on the back of easing energy costs and food inflation and employment and wage growth have remained solid. This combination has meant that the doom laden predictions of late 2022 have not come to pass.
Fundamentally, for the UK stock market to perform well for investors, two ingredients are required: firstly, growing earnings, and secondly, an attractive valuation starting point. We believe that both are in place. There is a collection of both strong international and well placed domestically exposed companies available in the UK market, and currently such investments are available at attractive free cashflow yields. In our view, this provides a strong starting position for the investor looking to invest against the crowd.
Turning to monetary policy, the Bank of England has to walk a tightrope between raising rates enough to prevent inflation becoming embedded, and not raising such that the economy is damaged. It seems the balance is now swinging towards it being the peak level of rates. Generally speaking, there tends to be a lag between policy rate rises and their impact on the real economy, and with that in mind, it seems likely that the effects of recent rapid rate rises are only just beginning to filter through. Given this, monetary policy makers are rightly cautious of further rises, as seen in the most recent decision to hold rates flat.
A prolonged period of higher rates may feed into greater pressures on both the domestic and corporate purses. This is not a positive for equity markets, however, the scenarios priced into many UK listed companies already assume something of this, so we believe that selecting those companies with unique business models, sound financing and attractive valuations provide opportunities for active investors.
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