A Spotlight On: UK Equities

Following the recent UK budget, we were joined by Scott McKenzie from Amati Global Investors , Neil Veitch, CFA from River Global Investors , and Hugh Yarrow from Evenlode Investment to discuss if any of the announcements from the Chancellor came as a surprise. Our experts also made the case for UK equity investing from a valuation perspective, despite ongoing outflows and prevailing systemic challenges.

The UK Budget - March 2024

While the Chancellor unveiled no big revelations, surprisingly little was mentioned about the reasons to be hopeful for the future. Yet, looking ahead, there are reasons to be cautiously optimistic regarding projections for GDP growth and inflation, which contrasts with the prevailing low confidence in the UK economy.

Still, despite no budgetary surprises, it was disappointing to see the continued lack of action by the Government to help revitalise the UK’s capital markets. While some steps have been taken, such as addressing UK equity exposures in local authority pension schemes and the introduction of the British ISA, more needs to be done.

Even though the British ISA seems tokenistic, it is at least a small acknowledgement from the Government of the challenges in future. In fact, there does seem to be a broader and growing consensus, among both governmental and private sector entities, of systemic challenges and the need for holistic solutions, beyond isolated policy interventions. Solutions need to address issues within capital markets but also support the entire ecosystem, from early-stage enterprises to market listings.

UK Capital market outflows

After years of underinvestment in UK PLC, there's now a pressing need for the creation and growth of robust businesses, to be supported by investments in the broader UK economy and infrastructure. Doing so should help nurture healthy companies, but listed companies need to reinvest in their own futures too.

However, merely increasing flows into the market won't suffice. To stimulate markets, action could be taken by mandating public sector pension schemes to invest a minimum portion in UK equities. Innovative financing mechanisms for private and growth companies to alleviate market constraints are also another option.

Political landscapes

In the next UK #election, it is expected the winning party will be Labour. Despite being a change of Government, this will likely still result in a centrist economic policy framework aimed at fostering growth and stability. Lessons from past economic policies in the last 18 months, from the Truss budget, will likely lead to a cautious approach. Furthermore, in 2024, around 50% of the global population will face democratic decisions, including the pivotal US election. Against this globally turbulent backdrop, the UK scenario seems relatively calm in comparison.

Interest rates

The pandemic's impact on interest rates has been notable. While it initially caused deflationary pressures, it eventually led to a significant surge in #inflation rates, surpassing 5% in some regions. Despite strains on sectors like private equity, there are positive aspects, with well-capitalised and efficiently managed businesses positioned to strengthen their market share and competitive edge amidst challenging conditions.

UK Valuations

UK valuations are notably cheaper compared to the US and other developed markets, which gives potential cause for concern. Valuations, while limited in short to medium-term predictive power, significantly impact long-term returns. However, looking back on historical market cycles, past winners rarely retain their positions in subsequent cycles. So, despite recent surges in US valuations, taking a medium to longer-term perspective suggests the UK appears undervalued.

The small-cap market has faced significant challenges, with valuations now several multiples lower than in recent years. This downturn in valuation is concerning as it's resulting in companies seeking listings elsewhere, such as on NASDAQ, to achieve better valuations. Additionally, increased M&A activity among UK-listed companies reflects a frustration with low valuations, posing a significant obstacle to the health of the UK stock market.

Looking at larger, internationally focused companies, there's still room for valuation opportunities compared to their counterparts in the US, despite recent challenges. For instance, companies like Spectris are global market leaders with attractive valuations, offering a margin of safety for long-term investors. So, although the UK equity market has faced difficulties in recent years, the current modest valuation environment presents an appealing starting point for long-term compounding. That being said, there's a risk of takeovers with depressed valuations, potentially depriving investors of the benefits of long-term compounding from high-quality businesses.

Mamp;A

M&A activity and share buybacks are becoming increasingly common in the UK market, raising concerns about the de-equitization of the market. However, this trend isn't unique to the UK, with major markets globally experiencing similar declines in the number of listed companies. While consolidation and the rise of private equity play roles in this phenomenon, a thriving domestic economy would support early-stage businesses and sustain the stock market.

Again, like takeovers and despite the benefits of M&A, there's a risk of losing high-quality businesses capable of steady growth and value creation, emphasising the delicate balance between healthy M&A activity and preserving long-term value.

Director and share buybacks

Over the past few years in the small-cap space, the significant outflow of funds from UK equities, exacerbated in recent times, has prompted companies to respond with buyback programs. While typically companies are encouraged to reinvest rather than buy back shares, the exceptionally low valuations for some decent businesses justify this approach. A significant portion of top holdings are therefore engaging in share buybacks, indicating a shift in market dynamics caused by extraordinarily low share prices.

IPO Potential in the UK

Currently, there is a lack of interest in UK IPO activities. Yet, a healthy IPO market fosters capital market growth and participation in early-stage businesses, so barriers hindering IPOs and capital-raising opportunities need to be addressed. For example, a balanced regulatory approach that keeps capital markets transparent is needed to incentivise companies to list within the UK.

Despite the challenges, the UK economy has potential for growth, particularly in the emergence of “unicorns” and innovative businesses. A consistent policy approach to supporting businesses throughout their journey will be paramount, as will the importance of balancing dividend streams with long-term organic investment for sustained growth and value creation.

Watch the full panel discussion here.