Inside the mind of investors - May 2024

The markets tell us what investors are doing. But what, exactly, are they thinking? Towards the end of every month, Edison takes you: Inside the Mind of Investors.

Will the dam hold?

UK stocks have been out of favour for a long time, with investors reducing their exposure in favour of US equities in recent years. The FTSE rally this year has shown a return to the UK stock market from both domestic and, mostly, international investors, driven by corporate takeovers, share buybacks, dividends and a strengthening UK economy. The biggest gains have been in the natural resources sector, from rising commodity prices (notably copper and gold), and in Financials, benefiting from now long-term higher interest rates.

Despite these gains, the FTSE has pulled back over the last few weeks, in part due to more uncertainty. UK headline inflation announced on 22 May saw a steep drop year-on-year to 2.3%, however this was largely helped by a government cut in the energy price cap with food and rent costs increasing. This has raised doubts over whether a cut will be pushed back or made at all this year. Despite worries, UK GDP was higher than expected (+25bp) and the Bank of England (BoE) and the IMF remain optimistic that a cut this year is a possibility.

Mark Clubb, executive chairman of TEAM Asset Management, comments: ‘The fundamentals of UK equities would suggest that it is cheap, especially on a comparative basis to the US. The recent impressive rally in the FTSE has been principally driven by corporate or quasi corporate (private equity) buyers of UK companies, as well as share buybacks. And some have been big. Note, buybacks may be good for shareholders, but not for liquidity, which international investors seek. Price direction is a function of buyers versus sellers, and have the buyers got more money than the sellers need? Domestically that does not seem the case; UK institutions have been selling consistently for decades. UK pension holdings of UK equities have fallen from more than 50% of assets to about 4% in less than 20 years and the retail investor has also withdrawn, with less savings and disposable income to make additional investments. I think the long-term future price direction for UK equities is now heavily reliant on overseas investors.’

While many investors have continued to sell, there have been a few notable positive calls on the UK market such as from UBS and HSBC. HSBC told investors recently that it believes pension funds have very little left to sell, ending the downward pressure on prices and thus signalling the bottom of the market.

Investors are watching the US for signals on interest rates, as is the tradition that the BoE will follow the Fed’s move. However, with worse-than-expected figures in the US this year and better-than-expected UK inflation and GDP numbers, the BoE may buck the trend, in a boost to the UK economy.

Non-farm payrolls were well below forecasts in the US, showing a significant slowdown in the economy since March numbers. PPI increased the most in 12 months and oil prices remain high despite retracting in the last few weeks on fears of Fed rate hikes. Inflation being stickier than expected raised doubts in the market that there would be a cut as was optimistically thought earlier in the year. Despite this, the temporary dip in the S&P 500 this month was reversed as the index recovered to all-time highs, driven by positive corporate earnings.

Fiorangelo Salvatorelli, CIO of the Alantra Global Technology Fund, said of this year’s FTSE rally: ‘Inflation is sticky so there is no certainty on interest rate levels and momentum strategies are popular, which can keep markets moving driven by liquidity, therefore it is difficult to determine how much the market may rise. Ultimately it will depend mostly on corporate earnings. The whole market globally was looking at Nvidia’s and other AI companies’ earnings, not just in the US. We must wait to see what will happen to valuation multiples in the medium/long term.’

Corporate takeover activity and buybacks, while beneficial in the short term for the UK market, could make things worse in the long term if they continue. British multinational mining giant Anglo American (AAL) recently rejected a ￡34bn bid from rival BHP Group (BHP), and paper packaging company DS Smith (SMDS) has agreed to a ￡5.8bn takeover deal by its bigger US rival International Paper (IP). Speculation from overseas investors and hopes of bidding wars, as tens of UK-listed companies sit on takeover bids, has driven up prices significantly. Higher potential valuations and executive renumerations have also been leading companies to list in the US instead. Long-term sustained growth in the UK market may help deter further de-listings, with some UK companies rejecting takeover bids in the belief they may see their valuations rise.

Mark says: ‘The UK weighting in the MSCI World Index currently stands at 4%, down from around 10% just over a decade ago. As a result of more de-listings, the percentage of UK in global constituents will only fall further. The make-up of the FTSE 100 index, if we lose some of the largest corporates, will shift to having smaller overseas sales ratios, which will put UK companies at risk of no longer being ‘must own’ for global investors. The UK economy is now only 2.3% of world GDP by purchasing power versus 5.3% in 1980. Will the dam hold?’

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Many thanks to comments and contributions from Mark Clubb, executive chairman of TEAM Asset Management, and Fiorangelo Salvatorelli, CIO of the Alantra Global Technology Fund.

Written by Marcus Paul