- Despite the UK facing the weakest economic growth prospects of any of the world’s major economies, including Russia, the country’s blue chip index hit record highs this week.
- In addition to the near-term market factors catalyzing investment flows into UK equities, analysts see more structural shifts in investor behaviour.
- “Boring is the new sexy. With a plethora of exposure to energy, commodities, consumer staples and healthcare companies, the FTSE 100 seems well positioned for the current environment,” said Jason Hollands, managing director at online investment platform BestInvest.
An employee views a FTSE stock index board in the atrium of the London Stock Exchange Group Plc offices in London, UK, on Thursday, January 2, 2020.
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LONDON — The UK’s FTSE 100 index closed above 8,000 for the first time on Thursday, with one analyst suggesting the reason behind the demand for UK stocks is that “boring is the new sexy”.
Despite the UK facing the weakest economic growth prospects of any of the world’s major economies, including Russia, the country’s blue chip index hit record highs this week, closing at 8,012.53 on Thursday.
After a rough year in 2022 as high inflation, steep interest rate hikes and declining consumer confidence set stock markets around the world on fire, the UK market kicked off Friday with a 7.5% year-to-date gain in 2023, though that lags behind on the 9.5% gain on the pan-European Stoxx 600 index.
The FTSE 100 fell 0.25% in mid-morning Friday in London as risky assets sold across Europe, though the losses were significantly smaller than those in France and Germany.
“At the moment, the UK and Europe are in an ideal situation for inflation; it’s not exactly cooling down fast, but it’s cooling down faster than many expected,” said Danni Hewson, head of financial analysis at UK investment platform AJ Bell.
“That builds confidence that consumers may have just enough to get by; that those controversial profits of those energy giants won’t stick around forever because the price of energy is rapidly falling.”
UK annual headline inflation fell for a third consecutive month to 10.1% in January, although it remains well above the Bank of England’s target of 2%, while the labor market remains unusually tight.
Eurozone headline inflation also fell for a third straight month to 8.5% in January, coming back down to earth slightly faster than the UK
Despite expected recessions, the UK and European economies have so far managed to slightly exceed expectations and avoid a downturn.
The UK has also benefited somewhat from a return to economic stability following last year’s market turmoil in the wake of former Prime Minister Liz Truss’ ill-fated economic plan.
Meanwhile, mild weather in northern Europe and high levels of natural gas storage have ensured that the region has managed to stave off energy shortages for this winter.
Higher gains in sectors heavily weighted in the FTSE 100, such as energy, commodities and financials, have also helped lift the index, along with a weak pound helping to collect dollar-denominated foreign earnings.
The index is largely made up of multinational companies with a large share of dollar-denominated earnings, and offers investors relatively high dividend payouts.
But beyond the short-term market factors catalyzing investment flows into a market that has spent many years in the wild, analysts are seeing more structural shifts in investor behavior.
“Despite the new high for the index, UK equities remain incredibly cheap, with the FTSE 100 trading at a multiple of 10.7 times forward earnings. This is low compared to [the] longer-term trend and it’s also one of the biggest discounts to the rest of the world in living memory,” said Jason Hollands, director of online investment platform BestInvest.
“This is a good starting point, pointing to the potential for further gains, while UK equities also offer an attractive dividend yield of around 4.0%.”
It has led major investment banks to look increasingly rosy about the UK, but many private investors remain skeptical amid gloomy prospects for the domestic economy.
“In recent years, many investors have dismissed UK blue chip stocks as ‘boring’ because they lack exposure to exciting sectors such as technology and social media. But in a more difficult economic environment, solid companies that generate reliable dividends are worth the effort to consider,” Hollands said.
“Dull is the new sexy. With an abundance of exposure to energy, commodities, consumer staples and healthcare companies, the FTSE 100 looks good for the current environment.”
In contrast, economic resilience in the US is viewed more negatively on Wall Street, with strong job data and falling producer prices being interpreted as a signal that the Federal Reserve can continue its aggressive rate hikes.
Too much too fast?
Despite the wave of positive news for Europe and the UK, not everyone is optimistic.
The UK government’s planned withdrawal of the utility bill support scheme and the lifting of the energy price cap for households means that the cost of living crisis is unlikely to abate any time soon. Meanwhile, higher interest rates and taxes, curbed fiscal stimulus and the fallout from Brexit complete an “unpleasant picture,” said Frederique Carrier, head of investment strategy at RBC Wealth Management.
Carrier also highlighted a risk to corporate earnings, which in the UK and Europe were largely supported by “covid-19-induced pent-up demand at a time when consumers have been swamped by stimulus efforts.”
“This backdrop has allowed companies to pass on higher input costs, driving margins higher than ever before, but the situation has evolved,” Carrier said in a note last week.
Pent-up demand has largely been exhausted, supply chain disruptions have largely resolved themselves and inventories have built up. Companies’ pricing power may erode, especially as evidence of downtrading to cheaper commodities grows.
As a result, Carrier suggested that the “easy” gains in the stock market may be a thing of the past as the economic backdrop remains challenging, although overall valuations in the UK and Europe remain attractive relative to the US, which has the regions on the radar investors should like.
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