Summer 2024 - UK economic and market outlook

UK investors naturally have more of a focus on domestic indices, but those with a home-country bias have left been disappointed for a long time now. It’s no secret that both the UK economy and markets have struggled since the Brexit referendum in 2016.

In recent times, inflation running consistently above its long-term average, a series of interest rate hikes, and stagnating growth have been among the main headwinds for the UK. But is the UK finally showing signs of emerging from the doldrums?

In this article, we’ll explore the current macro landscape, its challenges, and the opportunities across UK equities.

The macro outlook – pockets of optimism

In the UK, economic growth has likely bottomed out. The latest economic figures released in July from the Office of National Statistics (ONS) showed gross domestic product (GDP) flatlining in April, following growth of 0.4% in the previous month.

At the moment, there is a lack of pathway towards above-trend growth. That said, there are tentative signs of a recovery with manufacturing PMI moving into expansion territory.

The UK inflation outlook is still uncertain with rising prices in certain sectors, such as services, proving to be the Achillies heel for Andrew Bailey and the Bank of England’s (BoE) Monetary Policy Committee (MPC).

The UK Consumer Price Index (CPI) rose by 2.0% in the 12 months to June 2024 – the same rate as the previous month. While this is in line with the BoE’s 2% target, the members of the MPC will be concerned with the rate of inflation in the services sector – which has remained stubbornly high at 5.9% and down marginally from 6.0% in the previous month. Given the current inflation profile and upside risks, the BoE is unlikely to make any significant cuts to interest rates for the remainder of 2024.

In our view, to fully realise UK growth potential, the most crucial factor will be the ability to implement planning reforms. This includes upgrades to the UK’s aging infrastructure and addressing the housing shortage, which are currently having a negative impact on disposable income, labour force growth, and productivity.

Valuations – cheap on an absolute and relative basis

The UK equity market continues to be cheap on both an absolute and a relative basis.

Interest rate hikes have weighed on investor sentiment, creating value opportunities in segments of the market. The FTSE 100 index and the FTSE 250 index are trading at just 12 times earnings, which is attractive relative to historical levels and other developed markets.

Despite what appears to be a good value opportunity on the surface, looking beneath the bonnet, the headline valuations for the UK are weighed down heavily by a large number of poor stocks. Good stocks are expensive, and the presence of struggling firms dampens the index’s overall performance.

With a lot of negative sentiment currently priced into the UK equity market, it’s likely to be creating a valuation cushion, while earnings expectations look a lot more realistic. The sector exposure of the FTSE 100 provides a hedge within portfolios in a scenario where inflation does not abate as quickly as anticipated. Energy, utilities, and healthcare companies make up around 35% of the index. Rising commodity prices should help producers to act as a hedge against inflation, while healthcare and utilities companies tend to have pricing power, allowing them to rise prices in-line with rising costs.

Our view on UK equities

The UK market has been riding on a wave of momentum in recent months, as some investors have become more positive about investing in the UK once again.

However, we think some of this optimism is premature and the outlook for the FTSE 100 remains somewhat weak. While some sectors within the index have shown resilience and performed well thanks to their defensive aspects, other sectors continue to grapple with uncertainties related to global economic conditions and geopolitical tensions.

The improving domestic macroeconomic environment should bolster the FTSE 250 companies, which are more domestically focused, compared to the internationally oriented businesses that make up the FTSE 100 index. These companies often exhibit more agility and growth potential than their larger counterparts. Because of the poor sentiment towards small cap companies, we believe there is good upside potential within the space.

With this in mind, we prefer to balance our UK exposure between the FTSE 250 for its growth potential and FTSE 100 for its defensive aspects. Depending on the evolution of domestic and global macroeconomic outlook we will tweak these positions accordingly.

The bottom line

In our view, a move to being overweight UK equities would be premature, but we recognise the opportunities within and across the different UK indexes.

Midcap exposure continues to trade at valuation levels that are sufficient to provide headroom to further negativity and we look to continue building this position within portfolios.

Across our current dynamic asset allocation positions, UK equity exposure ranges from 2%-5% (depending on risk profile) and we remain neutral on the asset class.