In this interview, conducted by Fund calibre, fund manager Alexandra Jackson, discusses the challenges faced by the UK equities market, examining the impact of global events, rising bond yields, and third-quarter results on investor sentiment.
Alexandra provides a nuanced perspective on the housing market, particularly focusing on Rightmove’s resilience amid competition. Alexandra shares her views on the UK’s economic fundamentals, valuations, and why investors should keep a keen eye on the market in 2024.
Why you should listen to the interview: This is a challenging and confusing period for UK equities as investors grapple with conflicting views. While some see the UK stock market as a ‘buy and hold,’ UK wealth managers are clearly marking it as a ‘sell.’ The question remains: which perspective is correct? At these low valuations, Alexandra believes that the market is full of potential and investors would be wise to take a second look.
Please note, answers are edited and condensed for clarity. To gain a fuller understanding and clearer context, tune in to the ‘Investing on the go’ podcast.
This is what we found interesting this week:
High interest costs impacting companies — and the portfolio
“Some companies are definitely feeling the pressure of these high interest costs, and some aren’t. What we talked about earlier in the year was we really didn’t want to see those companies that have hard won operating profit growth – they’ve got higher revenues, higher prices and they’re keeping control of their cost base. But that higher operating profit is being eaten away by higher interest costs; that’s really frustrating. And we have seen a few of those, in this fund fewer, I think, than the market as a whole because we focus on quality, and one of those classic quality factors is around the balance sheet. So, more than half of the positions in this fund carry net cash on the balance sheet, which is a nice position to be in.
“And then actually, if you exclude financials and property, we have nothing that has over two times net debt-to-EBITDA leverage ratio. And in fact, only 13% of the fund has net debt-to-EBITDA over 1.5 times. And we really don’t want to change that at this point in the cycle.
“The other point obviously is not just that kind of single number, it’s also the structure of the debt whether it’s fixed or floating, that’s been the most important thing. Obviously it’s only the floating debt that will be subject to these higher rates and when the refinances come, so that’s important to look at as well and takes a bit more time.
“And then, as I said, that’s the kind of direct impact, but then you’ve got that indirect impact, which is essentially what central banks are trying to do with higher rates, which is to dampen demand a little bit.”
There’s so much opportunity!
“I would say it’s a mixed picture and quite hard to get a definitive handle on the current sentiment and valuations. There’s definitely some conflicting evidence at the moment. The Bank of America/Merrill Lynch fund manager survey recently in November put the UK at the bottom of its list. And that reflects the mood that I hear at conferences and things like that; people do feel quite depressed.
“But then, I look at flows in the industry – or outflows as we should probably call them now – which are continuing, and actually, possibly not improving yet. And then I look beneath the outflows. We are still in net outflow as an industry from UK equities, but actually it’s UK wealth managers who seem to be doing the majority of the selling still.
“I guess those are the people who are overweight UK equities still. And that is being offset – not totally – but a little bit by US investors who are coming in to kind of cherry pick some assets. And that’s really, really interesting to me and gives me some comfort — some hope, definitely.
“But the global investors that I talk to, they’re quite confused why UK assets are still so cheap, particularly the ones with growth and cash flow and those kind of factors that, when you see those in the US, those are the companies that trade on 25, 30 times PE. So, it’s a mixed picture, definitely, there’s still some depressed sentiment out there, but there’s so much opportunity!”
“It’s appetite that’s missing”
“It’s been a rough ride over the last 18 months or so. The FTSE 250 has performed poorly during the fastest interest rate cycle for 40 years. But if UK SMID was the area that got hit so badly when rates were rising, it stands to reason that they could be amongst the strongest to bounce back while we see the market becoming happier with the idea that interest rates have peaked and that the next move even is down. And actually, we see that the FTSE 250 has become really correlated with five-year swap rates, so that is quite a good indicator to watch.
“The other thing has been the slightly lacklustre performance of the economy, but actually at the end of the summer, the ONS had to really revise their GDP numbers quite significantly in the UK, showing that the UK wasn’t this outlier that people perhaps thought it was, and that actually we’re very much within the pack.
“The fundamentals from here look to me to be ok; you’ve got a nice chunk of consumer savings, the labour market is strong, the macro fundamentals generally look okay if not spectacular, but on 10.5 times, 10.4 times for the market overall, we don’t need spectacular, all we need is for inflation to keep following this downward trajectory.
“We’ve never seen so many FTSE 250 names trading on a PE of below 10 times this century, I would say. And we bemoan these valuations and the lack of interest, but actually this is the key to the opportunity ahead.
“And as we’ve talked about with Ergomed, private equity and other corporate buyers are interested in this opportunity. They are still swinging for UK assets. Hotel Chocolat was bid for a couple of weeks ago and also City Pub Group all on the same day. It shows you that long-term private money is very, very interested in the very good quality companies you can get in the UK on a postcode discount.
“Going into 2024, we like names with low leverage, as we’ve talked about; we are looking for companies that have innovation, that can drive their own market share, that secular growth, which means that the revenues of the business aren’t wholly dependent on the business cycle. We definitely don’t see a shortage of opportunities. I see this as a very target rich environment. It’s just appetite that’s been missing.”
Conclusion: In addition, Alexandra provides a detailed analysis of Rightmove’s two key characteristics that position it as a valuable indicator of the UK markets’ health: a) its dominant position in the UK property market, even with the recent entry of CoStar, and b) its established experience and durability, which positions the company well to weather the current downturn. Let’s hope this applies to the UK as a whole…
