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April 2024
UK: The sun also rises
The UK may at last be at a major turning point after a dismal decade of political disorder, economic instability and lengthy market underperformance.
Source: Bank of Singapore, Bloomberg
The bear case for UK assets is well known. First, public services are arguably at breaking point since the ruling Conservatives from 2010 limited government spending after the 2008 financial crisis. But despite the years of fiscal austerity, the UK still has large budget deficits as the chart above shows. Public spending is at 44.5% of GDP versus taxation at 36.1%.
Second, the 2016 vote to leave the EU has led to years of uncertainty for UK firms over access to the EU’s vast single market, deterring investment and growth. The shock has also resulted in the UK having five prime ministers (PMs) in the last eight years.
Source: Bank of Singapore, Bloomberg
Third, the dire UK response to the pandemic led to GDP shrinking over 10% in 2020 versus a 6.2% decline in the Eurozone and 2.2% in the US. Fourth, former PM Truss’s ‘Mini-Budget’ of unfunded tax cuts caused turmoil in UK bond markets in 2022 and, last, the Bank of England’s slow rate hikes after the UK reopened saw inflation reach a peak of 11% in 2022.
Economic mismanagement has led to investors and companies giving up on the UK. Major firms have de-listed, the FTSE 100 is just 10% higher than its peak of 6.950 during the late 1990s tech bubble, and the (British Pound) GBP at 1.28 against the USD is not far from its all-time lows as the second chart shows. But the UK’s economic cycle is turning up now. Last year’s recession is set to be followed by modest growth in 2024 and we expect falling inflation will let the BoE cut interest rates from 5.25% in August.
More importantly, the GBP and UK assets may rally sharply as soon as the current government calls the next election which must be held by January 2025.
Any new administration will face major challenges still from weak public finances, an aging population, climate change and rising defence needs. But the polls suggest the Labour opposition will win a sweeping majority as it did under former PM Blair in 1997, letting the UK enjoy political stability, fresh structural reforms - to tackle housing shortages, etc - and closer relations with the EU. The upcoming election may thus be the catalyst unloved UK assets and the GBP need to experience a broader recovery over the next few years.
On the equities front, stocks have de-rated significantly since the 2016 Brexit vote and the MSCI UK is now trading near the lowest forward price-to-earnings (P/E) levels relative to MSCI World over the last few decades. From a total return perspective, the UK offers a much higher dividend yield compared to other regions, in addition to the payout ratio being meaningfully below the historical average. Looking ahead, dividend strategies may also gain more traction if interest rates move lower as central banks start the cutting cycle. We see abundant equity opportunities in the UK and we note that measures have also been introduced in the recent Budget to encourage UK investment for UK companies.
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