07 Nov 2024
In June’s edition of Investment Perspectives, we talked about what was happening in the UK stock market and considered how the political landscape might affect its trajectory. Four months on and post the UK election, has the market experienced a turnaround or are we still waiting for that defining moment?
The London Stock Exchange (LSE) was once the world’s largest, but now sits in sixth place. The primary UK index increased in value by around 20% from 2015 to October 2024 and in contrast, the major US index grew by more than 250%. Over the past ten years, the value of the largest index in the US has grown ten times faster than the primary UK index so it wouldn’t be outlandish to conclude that UK capital markets are still in trouble.
Last year, 76 firms delisted from the LSE – up 62% on the previous year and some of the UK’s most vibrant companies have publicly stated that they wouldn’t consider listing in London; low liquidity, diminished investor confidence and a shrinking pool of capital aren’t stemming the exodus. UK defined benefit schemes are absent from the market and have been withdrawing from UK equities and the Financial Conduct Authority (FCA) believe that media coverage is exacerbating the issue.
We know that institutional risk-aversion within the UK’s pension and insurance systems, driven largely by regulation, has caused chronic under investment. The big problem London has is the retreat of both institutional and retail investors from the market. In the US, pension fund capital is the primary driver of capital investment, powering 72% of the venture capital sector as opposed to just 10% in the UK. To put things in perspective, in 1997, UK pension schemes allocated 73% to equities but today that figure has dwindled to a disappointing 31%. Over the same period, the portion of assets allocated to UK equities has fallen from 53% to 4.4%. On top of this, passive investment strategies have detracted from the efficient allocation of capital, particularly when it comes to the pool of finance available to smaller companies, so it’s not surprising that the UK economy has struggled to grow in recent years.
In modernisation and innovation terms, does the market reflect some aspects of the economy? Companies from established, slow-growth sectors make up a larger proportion of the UK’s public markets than those in other countries, like the US. Meanwhile, wealth managers chase returns as they seek to keep pace with their peers, many preferring to invest in high growth companies such as the so called ‘Magnificent Seven’. On a brighter note, the UK has one of the highest numbers of unicorn startups in the world and that figure has risen 25% over the past 12 months. Unicorns are new businesses with capital of USD$ 1 billion or more and they are highly innovative and market disruptive strategies. The UK market needs to be ready to welcome such companies as they grow. There is an increasing awareness of the need to reinvigorate UK equity markets, as the previous Chancellor set out in his Mansion House speech in October 2023, and in a number of proposals, and the current Chancellor will outline in her speech later this month. This is a view shared by a large proportion of UK equity fund managers.
How is the new UK government dealing with the imbalance? At the recent investment summit, the Prime Minister promised to address the impact of regulation on the UK’s appeal as a place of innovation and entrepreneurialism. Sir Keir Starmer said ‘There is a balance between regulation to order industries to function in the correct manner. But there is also a risk that you overregulate, and so you send capital elsewhere.’ He talked about reducing regulation that ‘needlessly holds back investment’.
How have markets responded to Labour’s first budget? UK equity markets are pricing in tax rises already, but fund managers still have concerns about the impact of government policies.
Chancellor Rachel Reeves’ UK budget included a £40bn tax increase, £28bn annual borrowing, and a £70bn spending boost for 2026-27. The budget provided some clarity for smaller companies and UK investors, but markets didn’t respond well with the major UK index taking a nosedive following the announcements. That said, there is an expectation that this course will reverse as we enter the often seasonally positive end to the year.
What does this mean for the investor? The cost of government borrowing did jump as markets digested the budget news with UK stocks, the pound and benchmark gilt yields going up, but some calm has since been restored. Pessimism is priced into the valuation of UK equities and compared to global equities and other asset classes the UK market is very affordable. UK inflation is falling faster than many developed economies, the Bank of England is cutting interest rates and we’re settling into a new Labour government. Economic and political stability are key to creating certainty in markets and this recipe could generate a wealth of opportunities for investors.
Without a vibrant capital market, it’s never going to be straight forward, but the problems are being addressed and there is a growing awareness of the need to revitalise UK equity markets. This is surely a good starting point, and hope remains firmly poised on the horizon.
Stephen O'Mara, Investment Research Manager
Katie Sykes, Client Engagement & Marketing Manager
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