The dim glow of the UK stock market
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The last time the UK stock market was as cheap as now — compared with the global average — was nearly 50 years ago.
It was 1973 and Britain was reeling from an oil shock and global economic dislocation, combined with strikes, fuel shortages and power cuts. I remember having to do my homework by candlelight.
Can Britain’s economic outlook possibly be as bad today? Or has confidence in UK stocks fallen so far that the market is seriously undervalued, with bargains for those ready to brave the headlines?
Clearly, the economy is in recession, with the IMF forecasting in a statement last week a 10.4 per cent plunge in gross domestic product this year, a partial recovery of only 5.7 per cent in 2021, and the prospect of output staying 3-6 per cent below pre-pandemic levels.
The pandemic casts a shadow over other countries too, as may the disputed US presidential election if uncertainty paralyses policy.
But the growth numbers put the UK among the weaker developed economies. While GDP numbers do not directly determine company profits, it’s a tough environment, notably for retailers and restaurant chains. And their foreign counterparts don’t have to contend with Brexit.
Little wonder that the FT All-Share index is still around 20 per cent down on 2020, while global indices are up, albeit marginally. As the chart shows, UK shares are at their lowest valuation relative to the MSCI World Average since the early 1970s, as measured by a combination of price/earnings, price/dividend and price-to-book ratios.
But still, with a lot of the downside in the price, could there be an upside? This week, the UK stock market barely reacted to Boris Johnson’s one-month lockdown. If that didn’t knock shares perhaps we are near the floor, limiting investors’ risks.
Contrarian fund managers are buying. Ian Lance of RWC Partners, an investment company, says: “Many people do the wrong thing: they panic and sell when the market is down and buy later when it has recovered. It’s psychologically very difficult to do the right thing.”
He is, for example, not put off by Marks and Spencer’s announcement this week of its first-ever half-year loss. He argues investors are overlooking the company’s fast-growing food business, with an in-house operation worth an estimated £2.5bn and a £1bn stake in online operator Ocado. That’s £3.5bn for a company with a market cap of just £2bn.
Then there is NatWest, the government-controlled bank, which is so carefully run that it boasts a tier one capital ratio of 18 per cent, a full 4-5 percentage points above target. That’s £31bn in cash — a big crisis buffer and a lavish fund for financing future dividends, once regulators allow payments to restart. Mr Lance sees a yield of 10 per cent in prospect.
He also likes Royal Mail. While bears focus on the lossmaker’s struggle to streamline its sprawling delivery services, he looks to its fast-growing parcels business. He calculates that GLS, the company’s EU-based parcels-only subsidiary, is worth £2.2bn — or almost all the £2.5bn market capitalisation.
More broadly, it is worth remembering that UK listed companies earn a lot of profit abroad — 70 per cent for the FTSE 100 groups dominating the market, notably oil and gas groups. While it may be out of favour for environmental and commercial reasons, BP yields a full 9 per cent, even after a dividend cut.
There might also be value in smaller international companies. Rob Burgeman, investment manager at Brewin Dolphin, the wealth manager, suggests Ashtead, an industrial equipment renter that generates a whopping 85 per cent of revenues in the US. It could benefit from any fiscal stimulus coming after the presidential election.
But that all said, the UK market suffers from a fundamental weakness going beyond the pandemic and Brexit — a shortage of tech stocks. The biggest source of global value creation in the last decade is largely absent, driving fund managers to look abroad, mainly to the US.
Peter McLean, research director at wealth manager Stonehage Fleming, says the UK’s share of the firm’s recommended equities portfolio was cut “quite materially” three years ago as money was redirected to the US in general and tech in particular. The UK share now stands at 5-7 per cent, compared to 40-50 per cent a decade ago. Even when post-pandemic recovery comes to the UK, this share allocation “won’t change materially”.
That’s not to ignore Britain’s powerful world-class companies. Unilever, GlaxoSmithKline and AstraZeneca, for example, are all profiting from pandemic-driven healthcare and hygiene spending, as are Diageo in drinks and HSBC in financial services. But they don’t compensate for the weak tech sector.
Half a century after 1973, we may not be short of electricity. But we could do with some more bright sparks in the stock market.
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