Why we think the timing is right.

My previous articles covered the 3 reasons why we’re optimistic for the UK in 2024 by looking at: the health of the UK economy (click here), the consumer (click here) and then finally the political landscape (click here). In this article I look at why we think the time is right to invest in UK equities.

The UK equity market has derated in recent years, with the FTSE All Share now trading on an estimated forward PE of c.10.5x.  The UK valuation discount to the Rest of the World materially accelerated in the wake of the Brexit vote and has remained stubbornly high ever since.  Even after adjusting for sector composition, since the UK is overweight Financials and Commodities and underweight Technology, a similar picture emerges of consistent devaluation.

For much of the past year, the UK market has been flirting with valuations only seen during previous crises such as the global financial crisis, the unwind of the TMT bubble and the Covid pandemic.  Currently around 10% of FTSE 350 stocks have a 12 month forward dividend yield greater than their 12 month forward Price-to-Earnings ratio.  When that 10% threshold has been previously breached, median 12-month forward FTSE 350 returns are over 25%. 

Valuation, however, is subject and while an excellent predictor of long-term equity market returns it often has little bearing on the short to medium-term.  Whether looking at an individual stock, or the market in aggregate, it pays to think of valuation as only one piece of the puzzle. 

A combination of cheap valuation, solid fundamentals, and improving liquidity typically delivers the best returns.  For reasons previously established, we are confident that the first two factors are in place for the UK equity market.  The latter factor, improving liquidity, will need flows to stabilise and could be helped by UK government reforms aimed at improving the health of domestic capital markets.  There have been calls for British ISA's and we’d hope for progress to be made on this front during the year.

Fund positioning

Our UK Opportunities fund is well-positioned to take advantage of improving sentiment towards both the UK economy and market.  Already in 2024, we have seen a number of takeover bids for listed UK stocks as third parties seek to acquire what they consider undervalued assets. 

Historically, the fund has been a beneficiary of such M&A activity with holdings such as Lookers and John Menzies being acquired at significant premiums to their undisturbed share prices.  Indeed, current holdings such as Entain and Elementis have been the subject of bid approaches in recent years. 

Given current valuations and the aforementioned improving sentiment, it would be a surprise if either private equity or larger international peers are not running the numbers on both these names and several other holdings in the portfolio.