If you’ve ever looked at a jumble of disparate words that seem to have no correlation until you investigate further, you’ve seen a word cloud. These are powerful tools across myriad industries, from art to science.
Essentially, a word cloud is a data visualisation tool. The bigger and bolder the word appears, the more often it is selected/voted for by an audience member. I recently came across one for UK equities – it was grim and confusing. Brexit, discount, cheap, unloved, outdated and old-fashioned were some of the prominent words.
In short, the cons significantly outweighed the pros. It is true UK equities have been unfashionable in recent years, particularly since we’ve seen added uncertainty caused by the Brexit vote (we’ve seen over £30bn of net retail outflows between 2016 and 2022).
We all know we’ve lived in a world of low interest rates for a number of years – something which has benefited tech stocks rather than the more value orientated FTSE 100. But, while that has begun to change, sentiment has not. Remember, the FTSE 100 was the best performing major index in 2022, albeit returns were pretty much flat.
I also remember the blue-chip index hitting the 8,000 barrier in February this year. It was at this point I was being asked whether the index was starting to look expensive – quite the opposite, it remains firmly unloved.
When this changes I’d argue we can expect further gains. We must also remember the index is the most mature dividend-paying market in the world – with many of these stocks remaining attractive in the current economic backdrop.
I still think the global argument is being overlooked.
Many column inches are being taken up with the view that the UK is almost too cheap to ignore now. Research from Franklin Templeton shows UK equities haven’t been cheaper on a relative basis since the global financial crisis.
It adds the UK market also looks cheap on an historical basis, with a price-to-earnings (P/E) ratio currently around 11x. Again, the last time markets were so cheap was during the global financial crisis and, before that, way back in the early 90s.
There are other factors also worth considering. For example, the UK consumer is still sitting on a fair bit of cash, having seen the household savings ratio surge, courtesy of the pandemic (household saving rose from 5.3% in 2019-2020 to 16.9% in 2020-21). While we’ve seen pension funds go from owning 50% of the UK market to less than 2% optimists would also say this is a nadir, with things likely to get better from here.
But I feel it is the global footprint of many UK companies that is perhaps being overlooked more than any other factor. For example, FTSE 100 companies derive more than 80% of their revenues from overseas.
Murray Income trust manager Charles Luke highlights the fact that the UK’s absolute discount to global markets sits at around 35%. However, the UK market has lighter representation in areas such as technology, which tend to trade on higher valuations. Adjusted for these sector differences, he says estimates suggest the UK market is at an approximate 20% discount to global equities.
His trust has roughly 75% of its assets exposed to international revenues and he says there are plenty of examples where there are UK companies with similar operations to a global peer, yet they are subjected to a significant discount.
He says: “BP trades at a price to earnings ratio around 40% below US-listed Exxon; Diageo’s valuation is around two-thirds that of US distiller Brown Forman as is Rentokil compared to US peer Rollins; Smith & Nephew trades at around 16x its annual earnings, compared to 25x for US-listed competitor Stryker. It is difficult to determine differences in the operations and prospects for these businesses yet there is a chasm in terms of their valuations.”
Another example is City of London investment trust, which prefers international companies listed in the FTSE 100. In a recent interview manager Job Curtis highlighted the likes of Shell and Exxon Mobil Corporation in the US, where the discount sits around 20% against the UK firm, the same is true for American Tobacco and Philip Morris.
Those looking for UK funds with a similar large exposure to FTSE 100 companies – and significant international exposure as a result – might look to the likes of the Artemis Income fund (which has over 80% in large-caps) and the JOHCM UK Dynamic fund (which has 75%).
Whether you are confident in UK PLC or not, this seems a natural route for investors to gain exposure to the home market at a discounted price. Many of these global companies are likely to re-rate once the market recognises their potential is only shrouded by the stigma attached to the region they reside in.
Darius McDermott, managing director, FundCalibre & Chelsea Financial Services. The views expressed above should not be taken as investment advice.