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Market Matters 13 May 2024

It was another good week for global financial markets, which have a bullish spring to their step. Strangely, I have barely heard the old adage, ‘Sell in May and don’t come back till St Ledgers Day’. This may reflect the more positive tone in sentiment or the fact I am getting older and there are fewer of us dinosaurs left that remember the old adages! For a while now, the UK has outperformed the US, and whilst it is far too early to declare the period of American exceptionalism over, it is a welcome relief to us UK investors who typically hold a higher weighting in our domestic market than benchmark MSCI World Index weightings. Europe joined the UK at the top of the weekly table, and Chinese equities continued to enjoy their renaissance. Bonds were remarkably flat.

In the absence of any significant piece of economic news coming out of the US, I thought I would focus on the UK market this week, where we not only got to hear from the Bank of England but also got the release of the first quarter UK GDP. Consensus suggested we would get confirmation that the economy had moved out of recession, and the data release didn’t disappoint, coming in right at the top end of expectations. GDP jumped 0.6% in the first quarter compared to the previous three months, as customers returned to shops spending their higher wages and investment rose again. Besides the gains in retail sales and investment, output improved with fewer strikes in the health sector. Growth in March alone was 0.4%, well above expectations due to a jump in services and manufacturing.

While stronger-than-expected growth could complicate the Bank of England’s path toward a potential rate cut this summer, the central bank, who would have had prior indication of the higher GDP print, set a dovish tone on Thursday as they kept interest rates on hold. In fact, after setting the stage for rate reductions in February and edging closer in March, this month saw the MPC advance even further along the path to rate cuts. While the policymakers did not explicitly signal impending actions, their statements suggest an increasing probability of rate cuts, which could come as early as June.

With only a 7-2 majority, the MPC opted to keep the bank rate steady at 5.25%, with Dave Ramsden supporting a 25bp cut. Additionally, the introduction of new phrasing in the policy’s final paragraph, ‘the Committee will consider upcoming data releases and their impact on the inflation risk outlook’ implies that the Bank of England has paved the way for easing when the numbers are confirmed.

That statement will increase market scrutiny on the two sets of inflation and wage data due to be released before the bank’s next meeting. Some economists have said that inflation could dip below the 2% target during that period, lending credence to the view that the first rate cut could come as early as June. Regardless of the timing, I suspect they will pursue a ‘cut and wait’ policy going forward rather than prescriptive cuts. Nudge them down, check inflation is still behaving, and if it is, then nudge them down again, but reserve the right to put the brakes on at any time if inflation or wage data misbehaves.

There was also the encouraging news that the BoE has raised its forecast for improving living standards, with an average wage growth of 5.25% this year, well above inflation. It may not feel like it for many people challenged by higher mortgage repayments, but with real post-tax household income in aggregate expanding by 1.75% this year, it will be well above the 2010-2019 average.

So, with an unusual dose of good economic news, a central bank prepared to cut even as growth forecasts are lifted higher, perhaps we shouldn’t be surprised to see the UK stock market breaking new ground, with the FTSE 100 sitting comfortably above 8,000. The investment case for buying UK equities has historically been predicated on the simple belief that it is a cheap market with a good dividend yield. Still, it would appear to offer better earnings growth prospects as a bonus now! Corporations have already spotted the opportunity with a significant increase in M&A activity, with bids coming in at substantial premiums to quoted prices.

It’s intriguing to note that the UK, which has historically underperformed, is now attracting global investor interest. Many institutional money managers are seeking better value opportunities outside of the US, and we’ve even seen the UK sector begin to outperform the US in recent months. For those who may feel they’ve missed the boat on the UK, I present a chart that surprised even me.

It shows the relative performance of the IA UK All Companies Sector vs the IA North American sector over the past decade. The extent of the UK’s underperformance was a revelation to me, and it may be to you as well!

Now, if the UK equity market were merely made up of companies that operated in domestic isolation, this trend could continue indefinitely. But that is not the case. Many of our large and mid-cap, and even many of our smaller companies, derive significant revenue overseas, and their valuations can be directly compared to US equivalents. Given that US equivalents can trade as high as double their UK counterparts, I see the playing field levelling from here. I am not saying that the UK market should trade on comparable multiples to US companies; there are many reasons why American businesses justify a premium, but the valuation disparity is too great, and the gap will narrow from here. For the first time in a long time, having a higher weight in UK equities than the benchmark MSCI World Index weight (circa 4%) makes sound investment sense.

This content is intended for financial professionals only. These are the author’s views at the time of writing and may be subject to change. This content is not intended to provide the basis for any investment advice or recommendation. Any forecasts, figures, opinions, tools, strategies, data, or investment techniques are included for information purposes only.

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