UK equities have generated good returns so far this year, and we believe that the market is in a sweet spot, supported both by healthy fundamentals and positive macro-economic factors, such as easing inflation.
Through August, the FTSE All-Share Index on a total return basis is up by 11% this year vs its 10-year average annual return of around 8%.
We’re optimistic that there’s further to go for this market, which has been unloved in recent years. We see a range of factors pointing in the right direction for investors: the market’s lowly valuation; the downward trend in inflation, potential for further rate cuts and modest but steady economic growth; the likely period of political stability after the summer election and the healthy pace of corporate activity.
Rate cut outlook
Starting with the economy, the UK market, and mid cap stocks in particular, tend to respond positively to falling prices for goods and services and the prospect of interest rate cuts. Traders are expecting as much as a percentage point of rate cuts from the Bank of England through November next year, following its August rate reduction, the first in over four years. The July inflation print of 2.2%, and data showing slower wage growth also are supportive.
The UK economy expanded by 0.6% in Q2 — not flashy but steady. Sterling, which acts as a kind of arbiter of the economy, is trading at a value of $1.30 per pound as we write, having touched a two-year high in August. The value of a pound fell to $1.07 at the time of the Liz Truss government’s mini-budget in September 2022.
Then there’s valuation: UK stocks are around 40 percent cheaper than their historic average, and are undervalued versus other regional markets. For value investors and contrarians like us, UK equities, in part due to their unpopularity, offer very good long-term possibilities.
Buyback surge
Companies also recognise this and have been buying back their own underpriced shares at a feverish pace — this has been a standout feature in 2024. BP has a two-year, $14bln buyback program, and Barclays plans to return at least £10bln to shareholders between 2024 and 2026 through buybacks and dividends.
In a typical year, FTSE 100 companies acquire £10bln-£20bln of their own shares. It surged to £58bln in 2022 and £55bln in 2023, according to AJ Bell data, and we expect a similar figure this year.
We believe the magnitude of share buybacks may soon exceed the amount of UK institutional selling of UK shares, a longtime feature of this market, which may act as an inflection point for domestic stocks.
M&A trends
Another sign of the mismatch between share prices and the underlying quality of UK plc is the pace of mergers and acquisitions. Private equity investors and overseas businesses have been snapping up UK companies — at price premiums of around 50% on average for companies that we follow. The list of deals and proposed deals include Hargreaves Lansdown, Direct Line, Royal Mail and the biggest but ultimately unsuccessful deal of the year so far – BHP’s £39bln offer for Anglo American.
More momentum, please
To be sure, we’d like to see more momentum in the UK market. The attention of global investors is focused elsewhere — on the US, the tech-heavy NASDAQ index and Japan. The US makes up 70% of the MSCI Global index, while the UK is a mere 4%.
It’s also true that a range of geopolitical risk factors, such as war in the Middle East, could make the market’s sweet spot turn sour.
Nevertheless, as investors we look for undervalued, cash-generative companies with strong balance sheets and reliable dividends and we’re finding plenty of good opportunities. We have been selectively buying shares of life assurance and energy companies, for example. The areas of dynamism in the market so far this year include Barclays, which is up 60% since its buyback announcement. Financial shares have been strong, as have the aerospace & defence and building & construction sectors.
The total cash yield (including dividends and buybacks) for the FTSE 100 in 2024 is over 6%. We are convinced that a UK equity income strategy has a key role to play in a diversified portfolio, and believe strongly in the power of compounding income over time for investors.
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
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