UK Stocks Just Hit a Record. That Might Be as Good as It Gets
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UK stocks just hit a record high, defying the country’s gloomiest economic outlook in decades. Scratch the surface, however, and the market is already falling behind.
While the FTSE 100 Index — home of blue-chip stocks such as Shell Plc, HSBC Holdings Plc and Diageo Plc — finally rose above its 2018 peak, it’s in fact trailing benchmarks in Europe, China and the US so far this year. On top of that, London recently lost its crown of Europe’s biggest stock market to Paris.
The FTSE 100 beat most European peers last year, thanks in part to the surge in oil and gas prices, which benefited energy giants BP and Shell. But on a longer-term view, the UK benchmark is virtually flat since the 2016 Brexit vote in dollar terms, while the S&P 500 Index has nearly doubled and the Euro Stoxx 50 Index has gained about 30%.
“Equity investors should consider opportunities elsewhere, for now,” says Vivek Paul, UK chief investment strategist at BlackRock Investment Institute. He sees more pain ahead for the country as policy tightening and persistent inflation take their toll on the real economy.
Trends that supported the FTSE 100’s outperformance last year, such as a rally in oil, weak currency and rising interest rates, are starting to wane or are better priced in.
Last year, the exporter-heavy gauge shrugged off domestic political turmoil, instead benefiting from a commodity rally. But Bank of America Corp. strategists expect that support to fade as economic growth loses momentum.
Other index heavyweights are also under pressure. While higher rates have boosted banks in the FTSE 100 over the past year, growing bets that hikes are peaking mean the upside from here on may be limited. At the same time, a strengthening pound is weighing on large-cap exporters that earn in dollars.
A rotation in investment style may also hamper the FTSE 100’s progress. Investors are piling into growth stocks after the Federal Reserve signaled some progress in taming US inflation. That’s likely to weigh on the FTSE 100, given it has a “bias to deep value and is very underweight growth and high growth stocks,” says Tineke Frikkee, head of UK equity research at Waverton Investment Management.
Global investors have been steadily defecting from the UK stock market since 2016’s Brexit vote, taking London’s edge as a global financial hub with them. Paris caught up with London as Europe’s largest equity market at the end of last year and is now firmly in the lead.
Locally, the situation is tricky. The FTSE 250 Index — whose constituents get about half of their sales in Britain — remains about 6% down over the past year as the UK confronts a sharper recession than many developed nations.
Still, the mid-cap gauge jumped by the most since November Thursday, extending an outperformance over the FTSE 100 this year, as traders bet the latest Bank of England rate hike will take it nearer to the peak of its cycle as inflation cools and a downturn takes hold.
Those who make the case for UK stocks note they are still cheap relative to European and global peers and offer international exposure. The FTSE 100’s dividend yield is also among the highest in the world. Among those positive on the shares is David Winckler, senior investment analyst at Kingswood, who notes heavy valuation discounts that implies a recession is already “largely” priced in.
“As the Brexit hangover fades and with some political stability, most UK assets look set to deliver superior risk-adjusted returns over the medium term,” he says, adding that economically sensitive companies look attractive and could outperform significantly.
Not everyone is as bullish. The FTSE’s underperformance versus the Stoxx 600 Index and the S&P 500 Index in January “heralds a pattern for the year,” write Bloomberg Intelligence strategists Tim Craighead and Laurent Douillet, expecting earnings at its members expected to drop in 2023 and trail peers’ recoveries in 2024.
“The FTSE is losing its lead as 2023 begins,” they write. “We believe its dramatic 10-15 percentage-point outperformance in 2022 is a thing of the past.”
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