There is a common misconception that the UK stock market is closely tied to the UK economy. However, recent facts suggest otherwise. The UK economy has faced numerous challenges, including high inflation, labor shortages, political turbulence, and supply chain bottlenecks. In comparison, other countries like Germany, France, and the US have also reported significant levels of inflation.
To combat inflation, the Bank of England unexpectedly raised interest rates by 0.5% in June. Additionally, the government is working alongside the central bank to reduce spending and borrowing. Concerns about the mortgage market remain high, with the average two-year fixed residential mortgage rate at a 15-year high of 6.66%.
Despite these economic difficulties, the performance of the UK stock market has remained strong. The FTSE All Share Index has outperformed the MSCI All Country World Index in sterling terms, returning 18.3% and 0.3% respectively, over 2021 and 2022.
One reason for this is that the FTSE includes globally focused companies. The top 100 companies by market capitalization derive about 80% of their revenues from international sources. Even the next 250 companies generate around 60% of their revenues from abroad, particularly the US. Therefore, these companies are more affected by the global economy rather than the UK economy.
However, there are also stocks in the UK market that rely heavily on the domestic environment. Encouraging signs have emerged, as factors driving inflation, such as supply shocks, fiscal and monetary policy stimulus, and labor shortages, are starting to reverse. Producer prices are normalizing, monetary and fiscal policies are tight, and the labor market is showing signs of slack.
Despite these positive developments, the UK market is still overlooked and under-owned, partly because of the misconception that it is closely linked to the UK economy. Additionally, the composition of the index, with larger exposure to energy, financial services, and materials sectors, and less exposure to growth areas like AI and tech, may contribute to this perception.
However, upon closer examination, one can find exposure to trends like AI, renewable energy, and digitalization within the UK market. The market is diverse, both in terms of sectors and investment styles, with attractive valuations relative to global peers. Furthermore, the macroeconomic picture in the UK is improving.
Another advantage of investing in the UK market is the healthy dividend yield. The FTSE 100 offers a dividend yield of 4.1% and is well covered by earnings at just over 2x. In comparison, Europe, Emerging Markets, and the US offer lower dividend yields.
In conclusion, while there may be an assumption that the UK stock market is intrinsically tied to the UK economy, recent performance and factors show otherwise. The global focus of many companies in the market, coupled with encouraging signs of improvement in the domestic environment, make the UK market worthy of consideration for investors.
