​UK stocks yearn for a turning point

Chip designer Arm Holdings shares jumped nearly 25% in its first day of trading after pricing an initial public offering at $51 a share. The IPO raised almost $5 billion, making it the largest US listing in almost two years.

It is a boon for both Wall Street and SoftBank Group that benefited from a stretched valuation but London likely turns sour on Arm’s popularity among investors.

Though still based in the UK, ‘the jewel in the crown of British technology’ snubbed its home turf in favour of New York for its listing.

But the global financial centre does not only bear the brunt of SoftBank’s dispiriting decision. UK equities have lost much of their appeal after its years of underperformance.

The FTSE 100, London’s leading index, has stayed nearly flat so far this year while other major stock indexes were on a roll. The S&P 500, for instance, has gained around 17% year to date.

The UK's FTSE All Share index is valued at around £2.28 trillion, roughly the same size as Apple, while British companies are trading at around a record discount to global equities.

Long-term logjam

Burgeoning government debt, crumbling infrastructure, political turmoil and consecutive rate hikes since late 2021 hurt investor sentiment.

A cumulative £76 billion has fled UK equity funds since 2016, according to Morningstar said, with the bulk of outflows in the last three years.

In contrast, global equity funds tracked by Morningstar have had £507 billion of net inflows since 2016.

Brexit may take most of the blame as UK equities began slipping into record discount territory on the heels of the independence referendum.

Goldman Sachs wrote that the effect on large caps has been small but there had been a ‘significant hit’ for domestic-oriented ones.

What makes UK equities a tougher sell is that gilts have offered a higher yield than Treasuries since 2022 as the kingdom is facing a bigger inflation problem than either the US or the eurozone.

The UK’s government debt in May reached more than 100% of GDP for the first time since 1961 as inflation cost billions of pounds in extra spending.

Interest rates affect whether businesses are able to meet their debt repayments and reduce their collateral for loans, which in turn weighs on banks’ balance sheets. That creates headaches for the economy with an oversized financial sector.

Moreover, the country has experienced the most tumultuous years in modern British politics. Rishi Sunak is trying to steady a rocky boat after his predecessor Liz Truss set a humiliating record of the shortest serving PM and Boris Johnson stepped down amid a series of scandals.

Brightening outlook

Economists polled by Reuters expect the UK to eke out 0.3% growth this year, trailing the eurozone but a stark contrast to late 2022, when many forecast a recession.

UK households are riding out the biggest inflation shock in four decades with their wages starting to outpace prices, which is reflected in consumer stocks’ outperformance.

Tesco celebrated ‘encouraging early signs’ in its Q1 trading report, in which it reported a like-for-like sales growth of 8.8%. The supermarket giant expected to be able to deliver a broadly flat level of retail adjusted operating profit in 2023/24.

Oil stocks, which accounted for a significant share of the FTSE 100, could be another tailwind to propel UK equities forward. Brent hit a new 10-month high last week on supply tightening by Russian and Saudi Arabia.

Sophie Lund-Yates, lead equity analyst at Hargreaves Lansdown, said that rising prices are ‘a licence for oil majors to grease their FCF and also allows further investment into renewable R&D.’

The outlook for European stocks is growing rosier as recession concerns ease, according to Bank of America’s latest survey of fund managers.

An increasing number of them have turned more bullish on stocks in the medium term though positions remain defensive due to gloomy short-term outlook.

However, fund managers also stressed the need for further stEPS from policymakers to revive local interest in British equities. A report showed UK pension funds reduced their allocation to British equities from 53% in 1997 to just 6% in 2021.

Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.