The news that the FTSE 100 Index of major UK-listed shares, aka the Footsie, had recently achieved an all-time high may seem baffling to many people given the very challenging backdrop of high inflation, rising interest rates, falling
real wages, strikes and the looming prospect of higher taxes.
Indeed, there has been a steady stream of very gloomy economic forecasts of late, from bodies such as the International Monetary Fund and Organisation for Economic Co-operation & Development, which have placed the UK at the bottom of their growth forecasts for major economies this year.
Faced with a steady stream of negative news, as well as the pain being felt in their own pockets, retail investors have been voting against the UK in their portfolios. Data firm Calastone estimates investors sold down £868 million from UK equity funds last month while pouring money into global funds. This makes January the 20th consecutive month of net withdrawals from UK-focused investment funds.
Ironically, while large numbers of investors have been heading for the exit on the UK equity funds, the Footsie was the best performing benchmark in 2022 among the major, developed equity markets globally. The Footsie has also started this year in rude health, rising 4.4 per cent in the first five weeks.
This seeming disconnect between the tough outlook for the UK domestic economy and the positive run from leading UK listed shares comes down to a widespread misconception that the UK stock market is a yardstick for the domestic economy.
This is certainly not the case and especially so when it comes the very large, highly international companies that dominate the Footsie. Collectively, these big beasts only make around 21% of their revenues in the UK. The revenues they earn in the UK are lower than the circa 27% they make in the US and less than they make across Asia. Seeing the UK equity market through the narrow prism of the woes facing the domestic economy
is a mistake.
Of course, the rest of the world is not immune from some of the global forces that have been confronting the UK, including high inflation and rising borrowing costs. But inflation does now seem to have peaked and although interest rates have continued to rise in many countries, an end to their ascent is now in sight. The decision to end draconian Covid restrictions in China in December following mass protests should not only see the Chinese economy rebound sharply this year, and in doing so help prop up global growth, but could also provide a welcome boost for large UK firms too as 13% of Footsie revenues are made in China.
The spring in the step for UK equities can be better understood by looking at the types of sectors that are well represented on the UK markets. Energy companies, which represent more than 12% of the UK stock market, have seen profits soar on the back of last year’s high oil and gas prices, but they have also benefited from taking
a much more disciplined approach to capital expenditure in the face of the global drive to reduce carbon emissions. Commodity giants are also in a sweet spot too, benefiting from surging demand for materials such as copper, nickel, cobalt, manganese and graphite for use in electric cars, batteries, smart phones and wind turbines.
It is also the case that the UK market has strong representation from sectors such as healthcare (11.5%) and consumer staples (17%), businesses which are typically resilient in tougher times. People do not stop taking medicine or buying everyday items such as toilet rolls and washing powder, or indeed enjoying their regular pint
of Guinness, when the economy slows.
Of course the question you may be asking yourself is whether the timing is wrong if the Footsie has scaled to new heights. Could this
be a sign the market has peaked?
My view is there is nothing to fear from this news. After years in the doldrums as investors turned their backs on the sorts of “boring” dividend-generating companies found on the UK markets in favour of exciting technology and online US stocks, the Footsie still has further potential as global investors spy an opportunity and private investors gradually wake up to the bargains on their own doorstep.
Far from being expensive, UK shares are cheap on pretty much every measure. The Footsie is currently priced at 10.3 times expected 12-month earnings, which is significantly lower than it has traded on average over the longer-term. Compared to global equities, which are priced at 15.3 times expected earnings, UK shares are at the widest discount to the rest of the world in living memory.
While private investors have been continuing to shun the UK, some of the bulge-bracket Wall Street investment banks currently have UK equities as a key pick. Moreover, the healthy 4.5% dividend yield on UK blue-chip shares represents a hefty premium to the 3.3% available on gilts, which is another way of assessing value.
Predicting short-term market movements with any accuracy is a mug’s game and of course surprise events can always provoke jitters,
as we certainly saw last year. However, for the
long-term investor I believe there are plenty of good fundamental reasons to take another look at large UK-listed companies again when mulling choices for ISAs and pensions in the run-up to the tax-year end, especially for those who have overlooked them in recent years.
Jason Hollands is managing director at wealth management group Evelyn Partners.
