The UK has become a bit of punching bag in recent times, stumbling from one crisis to another while presiding over an economy stuck in neutral. In many respects, it’s of little surprise its benchmark index has trailed the MSCI All Countries World index by almost 50% over the last five years.
Of late, stubborn inflation and negative growth have provided a distinct stagflationary feel to proceedings and, with an economy heavily reliant on old world industry and imported energy, it has been difficult to see a positive catalyst on the horizon. Despite all the doom and gloom however, there have remained pockets of optimism on the ground. For the most part, this has relied on some old-fashioned British pragmatism that things could hardly get much worse, however over the last few weeks we have begun to see signs of a more sustainable inflection.
The positive news is headlined by February’s inflation data which, while still well above the Bank of England’s target of 2%, was down sharply, falling to 3.4% from 4.2% the month prior, marking the slowest annual rate since September 2021. Service sector inflation which typically reflects domestic rather than imported pricing pressures also moderated to 6.1% from 6.5% (although it remains well above comfort levels, any decrease here is welcome). Promisingly, steady wage growth suggests we are beginning to see some stability in the labour market and sustained real earnings should provide a much-needed boost for GDP, which despite remaining modest, is at least starting to trend upward following a couple of consecutive quarters of negative growth.
It remains a delicate balancing act, and one month of below trend inflation won’t be enough to move the dial on the Bank of England’s policy outlook. However, it is certainly a marked improvement given where we were just a few months ago.
Of course, the market is a discounting mechanism and with current valuations trading near historic lows and the performance gap between the US stretching ever wider, any sign that fortunes are improving could help breath some life into the UK’s sclerotic indices. This is especially true considering the leap of faith now required in the US, which is facing its own stagflationary overtones, while trading on a multiple which can be politely described as generous.
This seems to be the view taken by BlackRock Throgmorton manager Dan Whitestone who, at the trust’s AGM last week, noted the relative attraction of UK markets at current prices. Dan, who is unashamedly a growth manager, thinks that the opportunity in UK small and mid-cap equities is one of the most attractive in recent memory. He says that the share prices of UK companies have become increasingly detached from their earnings potential and believes that they are ripe for a sharp bounce, which he thinks could happen very quickly.
Another trust beating the drum for UK equities is Temple Bar with managers, Ian Lance and Nick Purves, of the view that the opportunity in the UK market is as good as it has ever been. Ian and Lance are firmly of the school of value investing and believe that current UK market valuations, combined with a long overdue reversion to more normal market conditions after a decade of exceptional policy and quantitative easing, provide fertile ground for a rebound.
In their view, starting valuation remains the best predictor of investment returns over time. They also highlight the problem of recency bias, pointing out that, while investors may have got used to it, the success of growth companies through the 2010s is far and away the exception, and not the rule over the long-term. In fact, lowly valued stocks have outperformed their growth counterparts in every decade bar two in the last 110 years, with the other previous period of outperformance occurring in the 1920s.
For those with shorter memories, the outperformance of value, and the UK more broadly is not without precedence in this decade either. We only have to look back to the beginning of 2022 to what many saw as a paradigm shift away from US exceptionalism and a reversion to a more even dispersion of returns. In just over a year, the UK trounced its US counterparts by almost 30%, wiping away years of underperformance, which has only recently been surpassed by the AI driven bonanza we are experiencing today. As this short period showed, when markets turn they can turn rapidly, and with the UK slowly digging its way out of the economic doldrums we could once again be closer to that point than many think.
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