Has the Autumn statement provided a rallying call for UK equities?
Benji Dawes, co-manager of the Premier Miton UK Growth Fund, looks closely at what the Chancellor is delivering for UK business and investors with the Autumn statement.
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
UK stock market renaissance
For years the malaise around the UK economy, Brexit and outflows from UK funds has stalked the UK equity markets. Imagine a counter-factual where the UK’s inflation rate is tamed, the economy’s growth forecasts being upgraded, the Chancellor making tangible commitments to increase investment in UK business, and foreign investors are returning to UK equity markets in force.
In this counter-factual scenario, UK investors have their looked-for ‘catalyst’ in the form of a pro-markets and pro-business Government budget and begin to pour their savings back into UK Plc, capturing the well understood generational valuation discount on offer.
What’s the matter with this counter-factual? Well, one thing is clear. Other than the return of UK investors to domestic markets, it’s the reality we are faced with today, as we listen to Chancellor Jeremy Hunt deliver his speech.
The UK economy is undoubtedly in a rather better place than a year ago, and a dramatically better place than is reflected in UK stock valuations. The opportunity is not a trifling one. The UK stock market, represented by the FTSE 100 Index, offers a dividend yield more than twice that of its US counterpart – the S&P 500 Index; its earnings yield is close to two times that of the S&P 500 Index. The UK mid cap index (FTSE 250 Index) has outperformed its US counterpart (Russell 2000 Index) over the last twenty years, despite relatively poor performance over recent years. When (not if) the tide turns, as is ever the way with investment markets, the possibility is that relative returns may be the richest in decades for UK plc.
What is the Chancellor delivering for UK business and investors with the Autumn Budget?
According to the Office for Budget Responsibility (OBR) forecasts, the measures proposed will increase business investment by £20 billion per year over the next decade. The largest business tax reduction of a generation also comes with a 2% reduction in national insurance, which will boost consumers’ incomes and strengthen the workforce. These measures reduce business tax sustainably, with a commitment to permanent allowances for businesses making capital investments, supporting higher internal and foreign direct investment.
This latter measure is a positive surprise that extends the temporary “super-deduction” allowance, giving greater clarity and certainty to businesses investing in the UK. Further, the Government is seeking to support investment in UK markets. The OBR forecasts the measures should provide a much welcome incremental boost to GDP, even as inflation is set to decline towards the 2% target level.
UK investors are not blind to the generational opportunity they are granted by the discounted valuations of UK Plc.
They see, as others do, good companies whose share prices offer substantial upside reward. Understandably, as outflows have ground on for so many months now, the will of allocators to the UK is depleted, but night is often blackest just before the dawn, and as Buffett taught us, the moment of greatest opportunity is when others are fearful.
Cycles of greed and fear amongst investors are normal, leading to herd behaviour, investment bubbles and the occasional opportunity created by a dislocation, as observed currently in UK Plc. The herd that has fled should return and when the tide turns, it turns quickly, leaving those with little exposure swimming without their trunks.
That the UK market is ‘priced for recession’ is even more stark when set against an improving set of UK consumer confidence data released for November, which saw the sharpest improvement since April.
Eagles are circling
The ‘un-investable’ problem for the UK has been magnified by asset allocation flows creating a dripping tap of UK sellers. This is further amplified by other investors just keeping out of the way, so the lack of interest in UK Small and Mid-Caps is perhaps explicable, but of course the puck may get whacked back in the opposite direction.
While UK investors seek greener grass, there are eagle-eyed predators circling in the form of foreign and private equity investors. This year alone, companies like Dechra Pharmaceuticals, Ergomed and Ascential, which have created huge value over time for UK shareholders, have been taken by bids from foreign predators. Hotel Chocolat received a bid just recently at a whopping 170% premium to its market valuation. In all, there has now been more than $20bn of bids for UK plc this year alone, and the pace is accelerating.
Opportunity knocks and is getting louder
Observing valuations of UK equities relative to global peers, the disparity is clear. But the opportunities are nuanced. The UK remains two different markets with rather different and potentially opposing drivers. FTSE 100 Index, which has outperformed its smaller cap sibling over the last 18 months, is a nominal GDP growth play, given its large exposure to Oil, Miners and Banks, while the FTSE 250 Index remains a UK rate play. In fact, the correlation between (rising) UK interest rates and (falling) FTSE 250 Index is startlingly high. If interest rates have peaked and global growth is slowing, then the case for UK small and mid-caps, which sit at record low valuation levels, becomes extremely compelling on a relative basis.
Is anybody home?
An active, all cap approach to investing may be required to best navigate these challenges. Simply put, UK small and mid-cap companies could be off to the races if rates keep doing what they’re doing. For now, the market bloodhound has its new direction of travel. The road ahead for UK Plc is both long and bright.
A Zelensky moment for UK investors?
When Volodymyr Zelensky was offered safe passage for himself and his family as the Russian troops rolled in, he offered his now immortal line: “I don’t need a ride, I need ammo”. Perhaps this is UK equity investors’ “Zelensky moment”. And perhaps we should all be asking ourselves, faced with this momentous opportunity, “What will I do with my ammo?”
