25 Sep 2023
Should you invest in a dream or a reality? In the first of a two-part series, the Artemis UK equity income team explain why negative perceptions of the UK should give way to a focus on the strength of the underlying fundamentals.
Lazy characterisations of UK equities have become commonplace of late. It is almost de rigueur to portray the market as a relic of industrial history – an archaic arena overpopulated by leaden-footed commodity producers, financials and mature sectors offering none of the growth that investors have come to crave.
Inevitably, this has created negative perceptions. Take the recent raft of headlines declaring that the UK’s economy is in worse shape than Italy’s. Overseas investors in particular could be forgiven for picturing Britain as a scrapheap of rusting Hillman Imps – Google them, younger readers – compared with a viale of gleaming Ferraris.
Yet the truth, of course, is that most UK companies are global in nature, deriving about 75% of their revenues from abroad1. UK equities were among the few positive performers in 2022 and hit a record high earlier this year – albeit without conspicuous fanfare.
This underlines our belief that the UK is home to a greater number of excellent companies than many investors might imagine. Looking ahead, we believe these businesses could be well placed to benefit from the continuing shift away from low interest rates and easy money and the consequent normalisation of the cost of capital.
Easy money and the promise of growth
The UK has been out of favour since interest rates were cut to record lows in the wake of the global financial crisis of 2008.
Although historically low borrowing costs were supportive of asset prices in general, the benefits for ‘growth’ companies were especially notable. With capital having little or no price, these innovative businesses – many of them in the technology sector – became a focus for the supercharged exuberance of professional and retail investors alike.
This was good news for the US, where most of these growth companies were based. The tech sector, above all, witnessed considerable revaluations and came to account for more than a third of the S&P 500’s market capitalisation. The news for the UK, on the other hand, was rather less spectacular: the total return of the S&P 500 was more than three times that of the FTSE All Share between January 2009 and December 2021.
From QE to QT
Then, in early 2022, this extraordinary market environment was finally brought to a halt. Inflationary forces that had emerged as the economy reopened in 2021 were turbocharged by Russia’s invasion of Ukraine, while prices rose at 40-year highs in much of the developed world.
Despite their initial reluctance, central banks responded by unleashing the most aggressive cycle of rate hikes in decades.
Market leadership changed as dramatically as monetary policy. With capital once again having a cost and even offering an investment return, the price of patience effectively went up. Companies with elevated valuations came under severe pressure, leading to growth – king of the heap since 2009 – ranking among the weakest sectors in 2022.
Vision versus reality
It might be said that many investors bought the vision during the dozen years of low interest rates and easy money. It might also be said that now is the time to buy the reality.
The S&P 500 fell by nearly 20% in 2022. Meanwhile, investors in UK equities enjoyed positive returns. At the very least, this suggests the UK is tiptoeing its way back into the fold of fashionable markets to be seen around town with – notwithstanding the ongoing slew of dismal headlines about the country’s broader economic woes.
It is important to stress that we do not foresee some kind of seesaw effect. We do not expect a mirror image of the QE years, with UK equities reigning supreme and their US counterparts in the doldrums. We are simply making the case for a more balanced, equitable portfolio.
To some extent, last year’s solid performance was driven by exposure to commodities and defensive stocks. Going forward, we believe factors such as inherent quality and long-term investment in innovation will serve UK equities well in a sustained period of higher, normalised interest rates.
And in the final reckoning, frankly, it does not really matter whether those rates stand at 3%, 4%, 5% or even 6%. Ultimately, what matters when weighing up the renewed attractions of UK equities is that you believe capital will have a cost in the years to come – which we certainly do.
1Source: FTSE Russell
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