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The UK has been missing out on the stock market boom this year, but that may soon change.
While major stock indices in other countries are soaring, the UK has been left behind with only modest gains. However, when converted to dollars, the performance of the FTSE 100 appears more favorable, especially with the recent drop in the pound. Still, the UK is significantly trailing behind the US, Europe, and much of Asia.
Hargreaves Lansdown recently highlighted the UK market’s underperformance following a comparatively decent 2022.
Big investors are skeptical of the global stock market rally this year, and this skepticism particularly applies to the UK. Bank of America’s survey shows that a net 21% of money managers have a smaller allocation to UK stocks compared to benchmarks. This is a significant percentage. In comparison, the net underweight percentage for the US is a more modest 10%, and for the eurozone, it is just 1%. Despite UK stocks being attractively priced with a low price-to-earnings ratio of 9.7 compared to 13 in the eurozone and 24 in the US, global investors have been hesitant to invest.
Goldman Sachs has described UK stocks as experiencing a “buyers’ strike,” which is fitting considering the country’s ongoing industrial action. The bank points out that in the first quarter of this year, only corporates themselves were buying UK stocks through buybacks, while foreign investors and domestic funds were net sellers, albeit in smaller quantities. Although the government’s efforts to stimulate the markets have been well-received, generating demand for UK stocks from large investors will be challenging. Additionally, households are more likely to save funds in deposit accounts rather than invest in stocks.
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Furthermore, fund managers remain pessimistic about the prospects of the UK economy, largely due to homeowners holding short-term fixed-rate mortgages. Many households still have mortgages with a 1.5% interest rate that will increase to 5% or 6% in the coming months. As the effects of monetary policy lags persist, this situation can be lengthy and painful. However, it is worth considering a more optimistic outlook for UK stocks. According to Christian Abuide, head of asset allocation at Lombard Odier, the equity market is somewhat disconnected from the macroeconomic factors. He also sees potential opportunities in UK sectors such as pharmaceuticals.
Another significant factor to consider is the latest inflation data, released on Wednesday. Although the inflation rate remains high, with an annual pace of 7.9% in June, it unexpectedly dropped from 8.7% in the previous month. While it is important not to place too much emphasis on one data release, it is reasonable to hope that the worst of inflation may be behind us. This belief is supported by the recent drop in UK government bond yields and a surge in shares of homebuilders. As a result, UK stocks had one of their best weeks since 2020, with the FTSE 100 gaining 3%.
For stocks, the most significant impact of the milder inflation data was the approximately 1% drop in the value of the pound. This depreciation is favorable for the UK market. We can recall that in 2016, after the Brexit referendum, the FTSE gained 25% when the pound plunged.
Caroline Simmons, UK Chief Investment Officer at UBS Wealth Management, notes that less than a third of FTSE 100 revenues come from within the UK, so a strong pound can have a substantial impact. She estimates that a 10% increase in sterling could lead to a 7% decrease in FTSE 100 earnings.
Predicting currency movements is challenging, but it seems plausible that sterling may experience a period of weakness. This could be due to a decrease in the inflation rate, alleviating the pressure on the Bank of England to raise interest rates beyond 6%, or because the bank takes actions that negatively affect the economy.
While this is a sobering thought, it is not a reason to avoid UK stocks. It is possible that the buyers’ strike on the FTSE will end before normalcy returns to the country.
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