Why is the UK doing so well?

David Jane

Premier Miton Macro Thematic Multi-Asset Team

The UK equity market is having a good start to the year, at least compared to some of the bigger international markets. This week we take a look at why.

It should not need repeating that the UK stock market is not a reflection of its domestic economy. This is true of most of the major indices with the exception, perhaps, of Japan. The larger indices now comprise mostly large international companies which happen to have originated in a particular country and still be listed there.

An exception is the banks sector, which is largely domestically orientated in most markets. However, the performance of bank companies’ shares is very correlated to interest rates and bond yields, making them heavily correlated to each other across regions in any case.

It follows that the UK’s recent strong relative performance is a consequence of industry mix, rather than investors having any particular view on the outlook for the UK economy. Indeed, domestically oriented UK stocks, such as retailers, have been poor performers. This reflects the squeeze consumers are experiencing from inflation in energy and other basic needs, despite some wage inflation.

The real weakness in markets has been in the high growth and high valuation areas, such as technology, as interest rate rises begin to bite. The growth versus value debate is very heavily entwined with the interest rate outlook. Rising bond yields are bad for long duration growth stocks and vice versa. The UK has a paucity of growth stocks, especially in the tech arena, compared to most other indices.

On the other side of the coin, the current year has seen strong performance from areas such as financials, energy and materials. Energy for example, is less than 4% of the global index, but BP and Shell alone are over 10% of the UK benchmark. The same is true for mining and banks. Performance of these areas is heavily intertwined with the growth versus value debate, which itself is heavily impacted by the inflation outlook.

It follows that whether the UK continues to outperform other global markets very much comes down to whether inflation persists, for how long and at what level. This is probably the most important question facing financial markets this year.

It is reasonable to suggest that the current very high levels of inflation are unlikely to persist, if only because base effects will mean comparisons become easier as time goes on. However, in our view the coming years will likely see inflation become higher and remain more persistent than the trends of recent years. This comes down to a number of factors, including government spending, deglobalisation, ESG policies and the re-emergence of the global consumer following a decade of deleveraging.

If that proves to be the case, we expect those sectors that are so important to the UK market to continue to outperform over coming years. Also, in a more inflationary environment, bond yields are likely to be on a rising trend, crimping the performance of growth sectors. In contrast, the earnings and valuations of inflation-beneficiary areas will be seen as attractive, following many years of underperformance.

FTSE 100 Index versus MSCI World Index. The UK has potentially a long way to go to catch up with other markets.

Source: Bloomberg, 20.05.2016 – 26.01.2022.

We don’t look at regional weights to the degree that most other mixed asset managers do, we consider sectors and themes much more important than regions. However, as a consequence of the shift towards inflation-friendly areas, away from the full-on growth themes of recent years, our UK weight has risen materially over recent months, to levels not seen in recent years.

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Risks

The value of stock market investments will fluctuate, and investors may not get back the original amount invested. Reference to any particular stock does not constitute a recommendation to buy or sell the stock.

Government and corporate bonds generally offer a fixed level of interest to investors, so their value can be affected by changes in interest rates. When central bank interest rates fall, investors may be prepared to pay more for bonds and bond prices tend to rise. If interest rates rise, bonds may be less valuable to investors and their prices can fall.

Higher inflation can lead to some investments falling in value, particularly those with a fixed level of interest, for example government bonds and corporate bonds.

Changes in central bank interest rates can affect all types of assets, in particular, securities such as government bonds and corporate bonds that generally offer a fixed level of interest. If interest rates go up, the value of a bond may fall, and vice versa.

Forecasts are not reliable indicators of future returns.

IMPORTANT INFORMATION:

For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within this document.

Whilst every effort has been made to ensure the accuracy of the information contained within this document, we regret that we cannot accept responsibility for any omissions or errors. The information given and opinions expressed are subject to change and should not be interpreted as investment advice.

All data is sourced to Premier Miton unless otherwise stated. Persons who do not have professional experience in matters relating to investments should not rely on the content of this document.

For your protection, calls may be monitored and recorded for training and quality assurance purposes.

Issued by Premier Miton Investors. Premier Portfolio Managers Limited is registered in England no. 01235867. Premier Fund Managers Limited is registered in England no. 02274227. Both companies are authorised and regulated by the Financial Conduct Authority and are members of the ‘Premier Miton Investors’ marketing group and subsidiaries of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

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This section of the website and the content it contains is for retail clients only and by persons who are resident in the United Kingdom [who are not US persons]. Professional advisers should refer to the Professional Advisers site.

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The information contained on this website does not constitute an offer or solicitation to sell or purchase shares in the funds or portfolios or to provide you with other products or services. Any application or investment must only be made on the basis of the relevant documentation of the investment, such as, for example, terms and conditions. The information on this website does not constitute any investment, tax, legal or other advice. Persons who do not have professional experience in matters relating to investments should always consult with an independent financial adviser before making an investment decision. Any opinion expressed on individual funds, services or products represent the views of the individual at the time of preparation and should not be interpreted as a personal recommendation to buy or sell or otherwise trade all or any of the investments that may be referred to.

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