All eyes are on the UK just now following the death of Queen Elizabeth. Are the UK’s financial markets also at a turning point?
In a difficult year for most regions, UK markets have outperformed so far. The FTSE100 index of top 100 companies is down around 5.5% in Euro terms (and only around 2% in sterling terms).
What’s driven UK markets in 2022?
Two trends in particular have helped the UK stock market this year.
Firstly, it has a heavy reliance on resource stocks – both oil and gas, and mining.
The FTSE100’s biggest constituent is Shell, while fellow oil giant BP and global miners Rio Tinto and Glencore are in the top ten. Such firms have seen their value rise significantly this year as war in Ukraine disrupted the energy and mining markets in which Russia has a big presence.
Secondly, the UK market has a lack of technology firms, whose valuations have been harder-hit by rising interest rates.
In their place are many companies often seen as value stocks, many of which own strong brands well-positioned to navigate an inflationary era. Some examples are Guinness brewer Diageo, Ben & Jerry’s owner Unilever, and vaccine- and drug-maker GSK.
What’s not to like?
While UK markets may have avoided some of the worst losses in global stock markets so far this year, it’s not obvious they are positioned to prosper in the months to come. In fact there are several headwinds, including:
1. Inflation and in particular the cost of energy is hitting the domestic economy hard as winter approaches. In fact, the UK’s inflation rate is the highest of the G7 leading economies.
Compared to many other medium-sized economies like France or Germany, there is less of a social safety net, and recent weeks have seen a series of strikes in several sectors. France, by contrast, is nationalising its electricity provider, Electricité de France so it can control energy bills.
2. Energy and value stocks may not drive the recovery in markets. On a five-year or a twenty-year view, the value of the FTSE100 index is almost flat (ignoring dividends). When the storm passes, the UK market will still have little in the way of technology stocks, for example, to power its growth.
3. The resource stock rally seems to have run out of steam during the last three months. For example, Rio Tinto’s share price peaked on 3 March.
Lastly, the UK faces some unique political risks. The death of Queen Elizabeth marks an end to a 70 years of stability at head-of-state level, and a new government has just been installed.
Sterling has fallen in value as investors seek the safety of US dollars in troubled times. An unfunded energy bailout costing £150 billion or more has just been announced, placing pressure on the UK bond market, as the government issues new debt, effectively to pay consumers’ energy bills.
And the much-promised Brexit dividend continues to prove elusive.
It pays to be selective in UK markets in 2022
That’s not to say there aren’t interesting pockets for investment exposure in UK markets. Here are three ways to work a UK angle into your investment portfolio.
The UK offers interesting exposure to infrastructure assets, with returns linked to inflation, a general need for investment in the sector, and a legal and political framework which supports investment, for example via public private partnerships. For example, it’s possible to invest in anything from wind energy to healthcare infrastructure and toll roads via investment funds.
In an inflationary environment where equities and bonds are under pressure, the prospect of regular dividends backed by real assets and long-term contracts in an advanced economy looks attractive.
While a value-driven approach may have limitations for growth, it is an essential part of any investment portfolio. And UK markets in 2022 have some great examples, many of which have a relatively small exposure to the domestic economy.
Look again at Unilever, for example. It shares are down just 1.1% this year so far.
Home to some great brands in numerous markets, it’s been able to raise its prices by more than 11% over the last 12 months, offering a powerful defence against inflation.
Yet it trades on a Price/ Earnings ratio of 20, compared to its US peer Procter & Gamble, which trades on a PE of 24.
Vodafone is another example. It operates in more than 20 countries, and in fact its sales in Germany are more than double its UK sales. It also offers a strong dividend yield, currently more than 6%.
Worth it in the long run
And finally: at the end of it all, the UK remains the world’s sixth-largest economy. You can’t ignore it.
As John Authers noted recently on Bloomberg, the UK stock market multiplied more than 2,500 times during Queen Elizabeth’s 70-year reign. Inflation, in contrast, rose just 20 times. The country may be facing some tough times, but there are plenty of reasons to retain some exposure to UK markets in 2022 and beyond.
The conclusion: patience and staying in the game through thick and thin can yield results.
Looking for other investment ideas in 2022? Here are some useful links: