We have talked recently about how the UK equity market is cheap versus history and versus other markets. We believe there are two catalysts that are starting to have a noticeable, and, we hope, lasting impact on this valuation drag.
The first of these catalysts is easing inflation. It is clear the UK market responds positively to falling inflation and the prospect of interest rate cuts. UK inflation eased in May to a 2% annual rate, hitting the Bank of England inflation target for the first time in three years. Analysis of the last 50 years of data shows that after the first rate cut, the UK market rises much faster than either US or European markets over the following six-month period.¹
The second catalyst is the pace of share buybacks. We believe the magnitude of share buybacks may soon exceed the level of institutional share selling, and this may act as an inflection point. UK pension funds are winding down their sale of UK equities, having cut their holdings from 590 billion pounds in 1997 to around 120 billion pounds currently², to diversify their portfolios.
Buybacks stand out
Share buybacks have been a standout feature of company reporting in 2024. Companies such as BP have provided two-year targets to repurchase $14 billion to underscore their confidence in their balance sheet and their business. This development is feeding through to better share price performance. Another example, Barclays, is up around 50% at the time of writing since announcing a generous capital return programme.
We expect to see around 50 billion pounds in buybacks this year, and a total of 150 billion pounds over three years. This robust pace compares with a previous level of 10 billion to 20 billion pounds annually for FTSE 100 companies.
The new highs achieved by the FTSE 100 during May should also encourage a more positive narrative on UK equities. Furthermore, the total cash yield (dividend and buybacks) for the FTSE 100 in 2024 is over 6%, based on our estimates. We believe the UK market offers investors an attractive combination of dividend delivery and capital appreciation over the next 12 months, especially in a lower rate environment.
Devoid of drama
We haven’t mentioned the election thus far. We have noted in previous comments that the election was devoid of drama and decided without major policy announcements from either of the main parties. The new Labour government will face challenges, not least the state of public finances. Still, we are hopeful that a stable political backdrop after a period of upheaval will prove to be good for the economy and for market sentiment.
We would like to see some relief from the new government, such as the removal of stamp duty or the introduction of a domestic ISA savings plan, which would be beneficial for UK markets.
To be sure, there are domestic and global macroeconomic and political risks that can change the direction of markets and sentiment, and these require constant monitoring. It’s also true that the UK remains overlooked by many global investors.
Diversified portfolio
Nevertheless, we believe that a UK equity income strategy has a key role to play in a diversified investment portfolio, and we believe strongly in the power of compounding dividends over time.
As income investors, we look for companies with robust balance sheets, strong cash flow profiles and a willingness to reward shareholders with payouts. The companies we speak with are optimistic about their outlooks. We aim for our strategy to deliver income with the prospect of capital returns as the companies we invest in prosper. We feel confident that UK stocks offer good long-term possibilities, especially if the catalysts continue to take hold.
¹Source: Berenberg research, Eikon Note: Bundesbank rate cuts used as a proxy prior to inception of the ECB, as at 30 June 2024.
²Based on financial analysis of data from ONS, LGPS Advisory Board, PPF, Willis Watson, UBS.
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