UK equities have fallen out of fashion in recent years however, Martin Currie’s Ben Russon believes it is time to change the narrative to a more positive one.
UK economy exhibits resilience
Global economies, and indeed equity markets, began to struggle last year as rising inflation and interest rates led to worries about recessions and market volatility. In the United Kingdom, consumer confidence and retail sales fell precipitously in the autumn of 2022. This was around the same time that the Liz Truss administration introduced its mini-budget that caused chaotic movements in UK asset prices.
Even though the outlook for 2023-2024 remains challenging, the outturn for the UK economy is defying the gloomier predictions and is proving more resilient than first feared. As a consequence, UK stock prices have been recovering and the British pound has improved as well. The movement of the UK’s currency is a good gauge of sentiment towards the country.
The principal reason that the economy is performing better than expectations relates to the ongoing strength of the labour market, with unemployment at historic lows, while at the same time job vacancies remain elevated as employers struggle to fill vacancies.
Ongoing Strength of UK Labour Market
Employment and Unemployment Rates (%)
2008-2022
Source: ONS as at 31 December 2022
Another factor to consider relates to the excess savings built up during the pandemic, providing a spending cushion and helping households manage their way through a higher inflation environment.
UK equities remain attractive
In our analysis, there are several reasons why UK stocks are attractive. First, corporate balance sheets largely appear to be in good health, despite the uncertain economic outlook. This has not always been the case during periods of economic weakness.
Looking across market sectors, aside from financial stocks, corporate debt is at very manageable levels. This means that corporations are in a good position to absorb rising finance costs—as interest rates increase—without upsetting their financial metrics. In our opinion, it would seem there would be little need for distressed rights issues or emergency equity raises, activities that we might have seen in previous economic downturns.
Second is that the UK equity market looks attractive to us on an historical basis with a price-to-earnings (P/E) ratio of around 11x.1 In our analysis, the valuation of the UK equity market also looks more attractive versus its international peers, with the MSCI UK Index 12-month forward P/E at the bottom of its historic range relative to that of the MSCI World Index.2
UK Equities are Relatively Cheap
MSCI UK Price-to-Earnings (P/E) Relative to MSCI World
31 March 1996 - 29 March 2023
Source: Bloomberg as at 30 March 2023
Third, while the British pound has gone a long way from moving towards parity with the US dollar as market commentators talked about last year, it is still at the bottom of its historic range. This situation reinforces the attractiveness of UK assets to international buyers, in addition to the aforementioned attractive valuations.
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British Pound (GBP) Weakness Presents Opportunity
GBP vs US Dollar (USD)
