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Despite facing a mix of economic headwinds, the FTSE 100 UK index of blue-chip companies managed to eke out a return of about 1% over the course of 2022.
The return, while nothing to write home about, was a relatively bright beacon in an otherwise gloomy year for stock markets worldwide. The US S&P 500 was down 18% over the same period, while the pan-European Eurostoxx 600 retreated by about 12% during the year.
Buoyed by energy companies announcing monster profits and renewed takeover talk in the banking sector, UK shares have continued to climb since the start of 2023.
Not only is the Footsie up around 5% year-to-date at the time of writing (14 February), but the index hit a record high earlier this month. In recent days, it has come close to breaching the 8,000 mark for the first time.
Momentum has not been confined solely to the UK’s largest businesses. The FTSE 250, which represents the UK’s next largest 250 companies after the blue chips, is also up around 5% year-to-date.
We asked a panel of investment experts for their thoughts on the UK market, and whether this year’s encouraging start can continue.
Investing in shares is risky as prices can fall as well as rise. This means you might lose some or all of your money.
Q – Can UK share prices keep rising in 2023? What’s the thinking behind your answer?
Jason Hollands, managing director, Bestinvest
Yes. Firstly, company valuations are compelling. The FTSE 100 is trading at 10.3 x 12-month forecast earnings, which is cheap, despite the index hitting an all-time high recently. Current valuations are about 13% below longer-term average levels, and UK equities are also standing at their widest discount to global equity markets in decades. This is a good starting point.
Secondly, dividend yields are attractive at 4.5% based on forward earnings – the top end of major markets.
Thirdly, the sector composition of the UK market lends itself to the current environment, with high weightings to commodities and energy, as well as defensive sectors such as consumer staples and healthcare that typically prove resilient in tougher economic times.
Rob Morgan, chief investment analyst, Charles Stanley
Yes. UK equities could well build on initial gains, especially in the first half of the year. Many companies could be set to beat earnings estimates where market assumptions are too downbeat.
The rally in retail shares on better-than-expected trading conditions since the autumn is an example of how investors had become overly pessimistic about an earnings collapse.
David Henry, investment manager, Quilter
No. We don’t see the same outperformance for the UK as we did last year. Inflation is cracking and history tells us that international markets outperform the UK during periods when the rate of inflation falls.
Indriatti van Hien, portfolio manager, UK Equities, Janus Henderson Investors
Yes, we think they can. Investor sentiment is still low, and the year-to-date rally has been driven by short closing. In other words, demand for stocks has been driven by hedge funds reducing their short-selling positions rather than buying stocks.
There could also be an inflow of money back into the UK equities sector following torrid outflows in 2022.
Janet Mui, head of market analysis, RBC Brewin Dolphin
Yes, UK share prices could continue to rise. One of the main reasons why this might happen is China’s re-opening. This will boost demand for commodities, therefore benefiting the energy and resources-rich companies which help make up the FTSE 100.
Brendan Company, investment manager, JM Finn
Yes. The FTSE 100 in the current environment has many positive attributes. Its composition, with a defensive tilt and being overweight to the oil, gas and mining sectors, should see continued performance given the inflationary backdrop. Demand for commodities should remain with de-carbonisation supporting prices for copper, nickel and lithium, among others.
Ernst Knacke, head of research, Shard Capital
In the absence of a crystal ball, who knows? While not our base case, sentiment towards the UK is very negative and, as they say, “it’s darkest before the dawn”. The contrarian investor might see the light at the end of the tunnel, but this comes with a warning that it can yet get darker.
Q – How much more mileage is there to come from UK shares?
Jason Hollands, Bestinvest
Short-term markets are difficult to predict given the shifting sands of sentiment, and there is always the potential for nasty surprises – such as geo-political crises – to cause disruption. But, over time, if UK equity valuations move towards longer term average levels, this suggests over 12% upside, plus dividends.
How quickly it gets there is anyone’s guess.
Rob Morgan, Charles Stanley
We expect inflation to come down, but any signs of inflation re-accelerating may give investors pause for thought later in the year that higher rates are here to stay for longer. We therefore temper our optimism with this risk in mind.
Indriatti van Hien, Janus Henderson Investors
Valuations for both the FTSE 100 and FTSE 250 are trading at the bottom of their 10-year valuation ranges. This, in conjunction with potentially bottoming-out earnings, provides scope for a further market rally.
The market last year had already started taking account of forecast earnings downgrades to reflect the weakening macro environment. If these earnings downgrades come to an end, this would be positive for earnings momentum.
Historically there’s a strong correlation between earnings and share price momentum.
Janet Mui, RBC Brewin Dolphin
A mild upside is likely for the FTSE 100, due to its sector composition that is both more defensive and geared toward commodities.
Brendan Company, JM Finn
Volatility will likely remain. But the FTSE 100 is still at a discount to its international peers and, following last autumn’s mini budget, the weakness of sterling supports the multi-national constituents of the FTSE 100 index.
Ernst Knacke, Shard Capital
The market’s running on fumes.
Q – Which sort of companies are most likely to keep up performance?
Jason Hollands, Bestinvest
We feel most comfortable with larger, international companies on the UK market. The further you go down the market-cap spectrum, the more exposure to the domestic economy creeps in.
Rob Morgan, Charles Stanley
The omens are good for the heavyweight international companies that drive the performance of the wider index. UK assets had become too cheap, investors too disdainful, and a very low bar was set for businesses to beat market expectations.
The UK’s economic challenges are well documented and news headlines almost universally negative. Yet underlying corporate health looks strong, particularly among the larger, more internationally facing businesses.
David Henry, Quilter
The UK mid-cap space looks interesting at the moment and may well outperform large-cap during 2023. Earnings multiples are un-demanding and FTSE 250 companies derive 60% of their revenues from overseas, counter to the popular narrative that the mid cap index is solely a play on UK plc.
We may also see some merger and acquisition (M&A) activity in the coming months, as overseas buyers take the opportunity to pick up UK assets at a discounted price due to a weak pound.
Indriatti van Hien, Janus Henderson Investors
In 2022, the flight to safety and the performance of the UK’s 20 largest companies propped up performance of the UK All Share index leaving cyclical stocks trading at historic lows in comparison to defensives. We think this scenario has the strong potential to unwind this year, providing scope for the more economically sensitive FTSE 250 to outperform the more defensive FTSE 100.
Consumer discretionary was the pariah sector in 2022. But several factors, including a more optimistic earnings outlook, lower gas prices putting more money in consumers’ pockets, and lower raw material and freight prices should improve corporate profitability.
Janet Mui, RBC Brewin Dolphin
Sectors most likely to keep up their performance are energy, insurers, consumer staples and healthcare.
Brendan Company, JM Finn
Any company that has a good management, strong balance sheet and a good investment story is likely to survive short-term volatility.
The weakness of the pound and the de-rating of UK Plc all suggest a ‘cheap’ valuation across the board. A focus now on valuation rather than the growth opportunities, plus the possibility of overseas predators, all appear to give good support even at these levels.
Ernst Knacke, Shard Capital
We continue to like commodities in the medium-to-long term, with tailwinds from the Chinese economy re-opening, energy security and the global transition to net zero.
The UK equity market provides fruitful hunting ground for those investors looking for exposure to these themes.
Q – Where could the UK market end up this year?
Jason Hollands, Bestinvest
There is potential to make returns of between 10% and 15% across the full-year. Though I would caveat that for unforeseen events, like a re-escalation of the war in Ukraine.
Rob Morgan, Charles Stanley
A high single-digit return from UK shares between now and the year end is still a distinct possibility.
David Henry, Quilter
It could be that the UK’s index of leading company shares ends the year flat. Falling inflation is not good news for most of the biggest components of the FTSE 100.
There is also potential for a strengthening pound to weigh on the earnings of the biggest names in the index.
Brendan Company, JM Finn
The global economy is beholden to central bankers not making a policy mistake.
With a strong labour market across the world, the likes of the Bank of England, US Federal Reserve and European Central Bank could all raise rates too far, which could create a liquidity crisis and an economic shock.
Q – How should retail investors be thinking about positioning their portfolios?
Jason Hollands, Bestinvest
Many investors have shunned the UK in recent years, flocking to global funds and US equities, typically with a bias to growth stocks.
For those in this camp, it really is time for a rethink. Not only because of the opportunities cheap UK shares offer, but also an end to the dollar rally since October could start to bite if this continues to play out.
Large cap UK equities look attractive. So think about a FTSE 100 tracker, or well managed equity funds that are biased to FTSE 350 stocks such as Temple Bar IT, Liontrust UK Growth and Blackrock UK Income.
Rob Morgan, Charles Stanley
Investors should aim to have UK exposure in a diversified portfolio as it offers something different to other global markets.
More adventurous investors could weight their portfolios towards small and mid-cap in the expectation of a pickup in M&A and the prospect of the green shoots of economic recovery.
David Henry, Quilter
Don’t walk away entirely from areas that didn’t do well last year. The economic environment is very confusing, and it will pay at the moment to retain some humility and have a good spread of assets across your portfolio.
Janet Mui, RBC Brewin Dolphin
Investors should aim to retain a diversified exposure in UK large cap equities. The economic environment remains challenging, but we believe the worst in the equity market is past us. Volatility will present a buying opportunity.
Brendan Company, JM Finn
The need for diversification has never been higher in recent times.
Ernst Knacke, Shard Capital
We recommend investors seek professional advice. When considering investment portfolios, we believe the most important factor for investors is an active management approach which focuses on fundamental, high-quality businesses.
