Uk Equities: A Smart Investment Choice

UK equities have been unpopular with investors for several years, with the Brexit referendum in 2016 causing UK companies to fall in value compared to their global peers. However, despite the challenges, there are several reasons why investing in UK equities may be a good idea. Firstly, the UK market is characterised by its remarkable affordability, with substantial double-digit discounts compared to other developed nations. Secondly, the UK has a high dividend yield, and companies are buying back their own shares, which could boost shareholder returns. Thirdly, the UK has a stable business environment with a strategic geographic location, adherence to the rule of law, and an open economy. Additionally, the UK economy has shown resilience, with economic growth proving more resilient than expected in 2024. Furthermore, the new Labour government has put growth at the centre of its economic agenda, and there are signs that the UK economy will continue to grow. Finally, UK equities offer investors exposure to a global opportunity set, as many UK businesses operate globally.

UK equities are undervalued and trading at a discount

UK equities are currently undervalued and trading at a discount compared to their global peers. This discount is partly attributable to macroeconomic events, such as the extreme pessimism after the 'mini-budget' and the strength of sterling, which has put pressure on the top end of the FTSE. Brexit has also played a role, with UK equities plunging into record discount territory versus global stocks since the 2016 referendum.

The UK stock market is dominated by companies that find their customers and sales overseas, including global banks, energy companies, commodity producers, and pharmaceutical giants. As a result, only about a quarter of UK equity revenues are derived from the UK, meaning that when you invest in UK equities, you are gaining exposure to a global opportunity set.

Despite the challenges, the FTSE 100 has experienced a steady recovery from its pandemic low in March 2020, hitting a record high in April 2024. However, this does not mean that UK stocks are now expensive. In fact, they are trading at a significant discount to global equities and are well below their long-term median valuations.

The number of takeovers of UK public companies reached a decade high in 2023, and cheap valuations are spurring many companies to launch share buybacks, which should boost shareholder returns. The UK's new Labour government's plan to promote investment through a £7.3 billion national wealth fund may further increase interest in UK shares.

While there are risks and challenges, the UK equities market offers a strong dividend yield, and investors are being paid to wait for the market turnaround.

The UK economy is growing

Additionally, the UK's GDP growth outperformed both the US and the Eurozone in the first part of 2024, reflecting a relaxation of price pressures, including a drop in mortgage rates. This positive trend is expected to continue, with the IMF upgrading its forecast for UK growth in 2024 to 0.7%. The country's new Labour government has also made a commitment to putting growth at the centre of its economic agenda.

The UK's economic growth is further supported by a stable political outlook, which is more favourable than that of the US or Europe. This stability has the potential to attract foreign investment and rehabilitate the country's image as a destination for foreign capital.

Moreover, the UK stock market has been performing well, with the FTSE 100 reaching record highs. While there are mixed opinions about whether the market is undervalued or riding high, it is clear that the UK is presenting a compelling investment opportunity. This is particularly true for global investors, as many UK-based companies operate internationally, allowing investors to gain exposure to a global opportunity set.

In summary, the UK economy is showing signs of resilience and growth, outperforming other major economies in certain quarters. With a stable political environment, attractive investment opportunities, and a commitment to growth from the government, the UK is well-positioned for continued economic expansion.

Interest rates are falling

Interest rates are a crucial factor in determining stock market performance. When the Federal Reserve cuts interest rates, it generally causes the stock market to go up. Falling interest rates tend to boost the market. However, the relationship is not always straightforward.

The Federal Reserve cut its influential federal funds rate by 50 basis points in September 2024, marking the first rate cut in over four years. This decision was made to stimulate the economy and prevent a rise in unemployment. The cut brought the rate to a range of 4.75% to 5%.

Falling interest rates can have several effects on the economy and the stock market:

• Impact on borrowing: Lower interest rates make it cheaper for consumers and businesses to borrow money. This can increase consumer spending and business investments, leading to higher profits and a stronger economy.
• Effect on consumer spending: When interest rates fall, consumers may have more disposable income as their credit card and mortgage interest rates decrease. This can boost the economy as households have more money to spend.
• Business revenues and profits: Lower interest rates can lead to increased consumer spending, resulting in higher revenues and profits for businesses.
• Stock prices: Falling interest rates can lead to higher stock prices. Consumers and businesses are more willing to borrow and spend, which can drive up stock prices.
• Dividend-paying sectors: Dividend-paying sectors such as utilities and real estate investment trusts often benefit from lower interest rates as they can lock in lower financing costs and increase their future earnings potential.
• Large companies: Large companies with stable cash flows and strong balance sheets benefit from cheaper debt financing during periods of falling interest rates.
• UK equities: The UK stock market has been in the shadows compared to the volatile progress of US technology companies. However, UK shares have been gaining traction lately, possibly due to a search for value and yield in a falling interest rate environment.
• Political stability: The UK's political outlook appears more stable than in the US or Europe, making it a potential destination for foreign capital.

In summary, falling interest rates can have a positive impact on the stock market and the economy. Consumers and businesses benefit from lower borrowing costs, which can lead to increased spending, investments, and profits. This, in turn, can drive up stock prices and benefit specific sectors, such as dividend-paying companies and large corporations with strong balance sheets.

Political stability is returning

The UK's economic growth has been weak compared to other G7 countries, with the International Monetary Fund (IMF) forecasting a measly 0.5% growth in 2024. However, there are signs that the UK economy is set to improve. In July, the IMF upgraded its forecast for UK growth in 2024 to 0.7%, and the country has beaten both the US and the Eurozone in terms of growth so far this year. The Bank of England has also recently cut interest rates, signalling the start of an easing cycle.

The political landscape is also becoming more stable. The UK's post-Brexit years were marred by short spells of government, but the recent landslide Labour victory indicates that the country has the capacity for rehabilitation as a destination for foreign investment. The new Labour government has put economic growth at the centre of its agenda, and there is a broad consensus that interest rates will continue to fall.

The combination of economic and political stability may remove uncertainty for the UK market and present a wealth of opportunities for investors. The UK market stands out in valuation terms, with substantial double-digit discounts compared to other developed nations. The relatively low share prices of UK equities have led to a flood of merger and acquisition (M&A) activity, with corporates and private equity companies launching multi-billion-dollar bids for UK-listed companies.

The UK's business environment remains robust, with a strategic geographic location, adherence to the rule of law, and an open economy free from protectionist measures. The UK property sector, particularly in house-building and construction, is of particular interest to investors at the moment.

While there are still risks and uncertainties, the UK market is ripe for stock-picking, and investors should be able to find attractive opportunities offering compelling long-term return potential.

UK companies are buying back shares

UK companies are increasingly buying back their own shares, with nearly 40% of the FTSE 100 doing so in 2023. This is happening because companies are generating surplus cash and want to return this money to shareholders. Share buybacks can also indicate that management feels company shares are undervalued and are a vote of confidence in the company's prospects.

Share buybacks can benefit investors in several ways. Firstly, they can increase the earnings and cash flow per share by reducing the number of shares in the company. This can lead to higher dividends per share over time. Additionally, if companies are prevented from buying back shares, their share prices may rise as demand increases relative to supply.

However, there are also reasons to treat share buybacks with caution. Historically, companies have tended to buy back shares during bull markets when their stock is more expensive and refrain from doing so during bear markets when their stock is cheaper. This suggests that management teams may not always make objective decisions about when to buy back shares.

Furthermore, share buybacks can be used to manipulate earnings per share figures and trigger management bonuses. There is also a risk that companies may use debt to fund share buybacks, potentially weakening their balance sheets in the long term.

Overall, while share buybacks can be beneficial to investors, it is important to carefully evaluate the motivations and potential risks behind such decisions.

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