The FTSE-100 has barely moved since the election was called in late May. This is despite a new government with a substantial majority, promising a £70bn rise in annual public spending, alongside repeated promises to re-invigorate the UK’s capital markets. So, what is really happening?
It’s well known that since the Brexit referendum in 2016 the UK market has underperformed other mainstream markets. However that underperformance has been turning around.
Three-year FTSE returns, for a UK investor, have now caught up with MSCI World which is the main global benchmark for markets including the US and Europe. The FTSE-100 is up 25.6% over three years if dividends are included, whereas MSCI World (ex. UK) is up by an almost identical 25.5%.
Notwithstanding the gloomy narrative that often accompanies any discussion of the UK stockmarket, the FTSE is no longer at the bottom of the pack.
Despite these recent returns, the cumulative effect of many, many years of investor disinterest in the UK is that we now have a ‘cheap’ market. Every pound you invest in a basket of mainstream UK stocks such as those in the FTSE-100 buys you more earnings, by quite some margin, than it has done historically.
The valuation of the FTSE-100 basket of stocks is currently 12.2x earnings, which is modest, even if we adjust for sectors which should be lower valued such as banks and energy.
The UK’s position as a value market, with low exposure to some high potential sectors such as biotech and technology, somewhat counterintuitively means it is well setup if the world’s major economies move into a lower growth phase due to higher debt burdens.
We have ended up in an environment of ‘higher for longer’ interest rates which means that the post-2008 rocket fuel, of more than a decade of ultra-low interest rates, is not the backdrop that will frame returns for the foreseeable future.
A market such as the UK where much of the earnings growth is derived from cheap stocks with a durable earnings outlook, often enhanced by share buybacks, is not such a bad place to be, both in absolute terms and certainly from a diversification point of view for those UK investors who have previously steered away from their home market.
The unprecedented amount of bid activity for UK stocks is ongoing, with Ascential, Centamin Mining and Keywords Studios being some of our bid targets this year.
The prevalence of bids for UK plc acts as confirmation for those who think our markets are good value, and naturally it’s good for short-term returns, with Peel Hunt estimating that the average bid premium for FTSE 350 stocks is currently 40%.
This process of de-equitisation, whereby the retirement of shares through take-overs or buy backs exceeds new shares from IPOs or secondary share issues, can be good for investors in the short-term, but makes no sense for the country’s investment capability over the longer-term.
An element of our equity capital needs to be domestically owned and long-term in nature, whether in the form of pensions or mainstream funds, in order to provide a stable layer of support for investments in businesses and infrastructure.
For this reason the Labour party’s narrative, to continue the process of capital markets reform which began under the Conservatives, is welcome.
Chancellor Rachel Reeves has indicated that further to the budget, which is to be ‘one and done’ in terms of the significant rise in the tax burden, she wants to develop policy which is pro-markets and pro-growth, and she has a particular focus on the UK’s pension assets.
It won’t be easy to judge just how interventionist the state should be in investment markets. We need to avoid decision-making around pension allocations becoming too much of a political football.
However, the UK’s pension policy thus far doesn’t seem to be working in the nation’s wider interests. We have the largest pension market in Europe, and the third largest in the world, however according to a New Financial report, only 4% is invested into UK equities, which is considerably less than the domestic equity allocation in other developed markets.
Pension providers have already committed to a compact to increase allocations to unlisted equities by 2030, as part of last year’s Mansion House reforms. Maybe a more hands-on approach by the new government, to build upon last year’s reform package, might not be such a bad thing, if it leads to a better funding environment to support growth.
Graham Neale is a Partner at Killik & Co
