There was a fleeting period this year when it seemed like UK shares’ years-long discount to global markets might be narrowing. Now they are even cheaper than before that relative rally.
Despite that, it was revealed this week that Cevian, a value-seeking activist with a reputation for working with companies for years, had sold out of Vodafone after barely a year without much value improvement, and SoftBank cashed out of ecommerce company THG at a £450mn loss (and a discount to the day’s closing price).
There are complexities in both cases. Vodafone is a tough turnround job, made trickier by cost of living pressures that make it politically difficult for regulators to wave through mergers that might result in higher prices. The tech sell-off has forced SoftBank to retrench across the board.
What both examples arguably show, though, is that while UK stocks might look cheap, in the absence of an abundance of buyers they won’t necessarily provide value.
This is not new news. The UK has been inexpensive for six years. In that time the argument has been made repeatedly that UK stocks shouldn’t be so cheap, that domestic investors’ unwillingness to back the home stock market makes companies vulnerable to foreign takeovers, and that at some point, investors should see the light and buy UK shares.
These things are all true. Bids for Aveva, Avast, Morrisons, Meggitt and Pearson over the past two years show the FTSE 100’s appeal for foreign trade buyers and private equity. Yet it is hard to see the situation shifting in the imminent future.
UK equities are undoubtedly unloved, even if the UK has been the best-performing developed market this year in local currency terms. Bank of America’s fund manager survey for October showed global investors are more bearish about the UK than any other region (eurozone equities did come a close second). European fund managers, who were quite pro the UK in August and September are now neutral. Barclays’ analysis last week showed the biggest year to date UK equity outflows on their records, dating from 2006.
Meanwhile UK valuations (measured by the forward price-to-earnings ratio) are now at their lowest compared with their global peers on record, note JPMorgan analysts. UK prices average 8.6 times next year’s earnings to the US’s 16.3 times.
Some of that is down to the types of companies that make up the UK stock market. As Russ Mould of AJ Bell puts it, the FTSE 100’s earnings “are heavily reliant on the unforecastable (oils, mining, commodities), the indigestible (banks, life-and non-life insurers) and the interminably slow (telcos, utilities, tobacco)”. Low-quality earnings deserve low multiples. Simon French of Panmure Gordon estimates that the different sector compositions of the UK index can explain about half of the valuation gap. Part of it is also due to the US equity market’s bull run. And, he argues, there has been a “scarring impact of Brexit on the cost of equity capital for UK companies”.
The prospect of a recession clouds the outlook for the UK and eurozone. Domestically, there are arguments to be had about whether the benefits of a weak pound to the FTSE 100, with almost 70 per cent of its revenues drawn from overseas, continue to make it more attractive than the more heavily sold FTSE 250 (closer to 50 per cent international revenues, according to JPMorgan). Compared with the eurozone, the bank also argues UK earnings have tended to suffer smaller falls from their peak during the past five recessions.
The problem is that while UK equities are cheap, no one wants equities at all. Fund managers’ allocations to global stocks aren’t quite at an all-time low in BofA’s monthly survey — but only because last month marked the record low rather than this one. That leaves a smaller amount of money targeting UK equities at a time when big international asset managers were already wary of investing in a country that has steadily shed its reputation for stability.
There will be individual bargains to be picked up. There is money to be made. But it is hard to see the overall discount in UK share prices closing at a time when shares are spectacularly out of favour.
[email protected]
@catrutterpooley
City Bulletin
For an early morning round-up of the latest business stories sign up to Cat’s City Bulletin newsletter
