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Since the start of the year, the UK has started to emerge from its Brexit-induced cloud. A successful vaccine rollout and improving economic data have seen confidence return to the UK stock market. This is welcomed after a tough period, but can it endure for the longer term?
In recent years, the UK stock market has been held back by first Brexit and then the poor response to the pandemic. However, the performance of the UK stock market relative to other markets has improved since the start of this year.
There have been a number of drivers for this turnaround. The speedy vaccine rollout has allowed the UK economy to reopen and economic figures are improving. After contracting 9.9% in 2020, the UK economy is slated to grow by 5.3% in 20211. Pent-up savings, accumulated during the pandemic, are expected to give a long-term boost to consumer spending.
Also, the market mood has taken a more friendly turn. In recent years, global investors have prioritised a narrow range of higher growth companies in areas such as technology. In contrast, the type of mature businesses that dominate the UK market – oil and gas, banks or pharmaceuticals – have been out of favour. This has switched since November of last year as global economic recovery has taken hold.
Merger and acquisition activity has also been an important driver for UK markets, as international bidders have sought to capitalise on the discount at which UK companies trade relative to global peers. Corporate and private equity buyers have moved in, looking for companies with good cash flow that they can pick up cheaply.
The picture today
These factors have brought the UK market this far. From here, the UK market as a whole still has some tailwinds. In our view, valuations still look attractive relative to their global peers even after a period of stronger performance. After all, the UK has been weak for some years and the recent rally has only lasted a few months.
Equally, we believe the economic recovery is set to continue. Our view is that pent-up savings are likely to find their way into the real economy as people spend more on leisure activities and travel. The dividend landscape is also far healthier. Companies that had been overdistributing for a number of years reset their dividends during the pandemic, which allows them a better pathway for future growth. We look for businesses that can grow their dividends many years into the future and we find plenty of companies with that potential today.
We also continue to see new opportunities coming to market. It is easy to dismiss the UK as rather ‘stodgy’, but it has proved its dynamism over many years. We see a pipeline of interesting initial public offering (IPOs). Global private equity groups have plenty of cash at their disposal and will continue to swoop in on undervalued, cash generative assets. This should continue to provide support for UK share prices.
Nevertheless, there are risks. As economic activity rebounds, this has caused some strains on supply chains with specific industry shortages. Inflationary pressures are mounting, and we continue to monitor the bond market to determine if the current surge in inflation is transitory or could persist. We are also watching the evolution in the relationship between China and the West and the potential impact on industries and shares.
To our mind, the UK market still offers real potential, but gains may be harder won from here. We believe the market will become increasingly discerning on earnings potential and growth. We continue to prioritise businesses that generate sufficient cash to invest in their businesses and to pay a growing dividend as well.
Source: 1International Monetary Fund, March 2021
