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Our 2024 Global Outlook
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2023: A year in the round
Last year, the Bank of England paused UK interest rates after 14 consecutive hikes had brought them to a 15-year high. US interest rates also rose steeply before plateauing, with most central banks adopting the higher for longer narrative. That was until mid-December when the US Federal Reserve’s (Fed) surprise pivot from maintaining US interest rates, to talk of cutting them in 2024, sent both equity and bond markets racing into the year’s end.
1
Geopolitics
In 2024, we face a presidential election in the US and the prospect, but not the certainty, of a general election in the UK. As Stuart Clark explains, this means the world could soon look a lot different.
2
Emerging markets
China’s economic problems have undermined emerging market equities in recent years, further hampered by record US interest rates and a strengthening dollar, but, as Sacha Chorley explains, there’s more to the picture.
Contents
3
Fixed income
It’s been a tumultuous two years for bond markets. CJ Cowan explains what’s been driving this, what it means for multi-asset portfolios, and the outlook for high-quality bonds in the year ahead.
4
Growth opportunities
The Magnificent Seven may have ridden to the rescue of equity markets in 2023, but, as Ian Jensen-Humphreys observes, there are greater growth stories on offer from innovative companies that have yet to hit the headlines.
5
UK equities
The UK economy has fared far better than feared a year ago, but its stock market remains one of the world’s most cheaply valued. As Helen Bradshaw explains, this presents opportunities for investors in 2024.
6
Climate change
The UK is pushing back on some of its commitments to climate change and net-zero targets at a time when other countries are stepping up their efforts. Bethan Dixon provides an outlook for responsible investors.
2023 saw global equity markets shrug off inflation, a cost-of-living crisis, interest-rate hikes, and rising geopolitical tensions to deliver double-digit returns. Meanwhile, as Marcus Brookes observes, bond markets also delivered robust gains.
Europe climbed a wall of worry in the early part of the year as the German economy slipped into recession adding to fears of a lingering manufacturing downturn for the region. However, European inflation dropped to 2.9% in October, spurring hopes that interest rates could soon relent. This sent local markets surging in November and transformed European equities from being one of the year’s laggards, to being one of its leaders as the year drew to a close. Although the UK was the top-performing regional market of 2022, thanks to its heavy weighting to natural resources stocks, it was the poor man of Europe in 2023. UK returns lagged those of other developed markets while the economy narrowly dodged recession.
Europe bounces back
China suffered a second consecutive year of double-digit losses. Once again this dragged down Asian and emerging equity markets as the ripples from China’s imploding real-estate sector, and mounting geopolitical tensions with the US, continued to be widely felt. In contrast, Japanese equities made strong returns with data suggesting that the economy may finally have escaped deflation. This had previously meant that with prices falling, consumers delayed their purchases and contributed to the low-growth backdrop.
China struggles while Japan flourishes
With interest rates having likely reached a peak, and global growth expected to slow, government bonds are now offering diversification benefits that have been in short supply for much of the past decade. The end of an interest-rate hiking cycle, and the subsequent cuts that follow, often deliver sudden bursts of strong performance for equity and bond markets, meaning 2024 is a year to stay invested in both.
Interest rates and bond markets
Deflation is the general decline in prices of goods and services, which effectively increases the value of currency.
Marcus Brookes
Chief Investment Officer
Thanks to a sudden boom in artificial intelligence (AI) related stocks, Nvidia became the world’s most valuable chip maker after its shares gained upwards of 160% in the early part of 2023. It also introduced investors to the Magnificent Seven. This group consists of Amazon, Apple, Alphabet (Google), Microsoft, Nvidia, Meta (Facebook), and Tesla. These mega-caps had grown to account for around 25% of the US equity market by the mid-point of the year. The performance of these US stocks was a big part of the outperformance of growth stocks in 2023 and the strength of the US equity market, which left other major markets in its wake.
The Magnificent Seven Ride!
With thanks to our investment partners for their contribution:
2024: The outlook for markets
Watch Lindsay James, Investment Strategist, explain the outlook for markets and what it means for investors.
Our contributors:
Lindsay James
Investment Strategist
Stuart Clark
Portfolio Manager
Sacha Chorley
CJ Cowan
Ian Jensen-Humphreys
Helen Bradshaw
Bethan Dixon
Long before the ‘pivot’
Before this, 2023 saw the resurgence of growth over value stocks. Large-cap stocks dominated the terrain, while small caps eked out a modest positive return after making strong gains in the closing months of the year. Although the first quarter saw the collapse of several US regional banks, sparking fears of a wider contagion and hastening the shotgun merger of Credit Suisse and UBS in Europe, markets were quick to recover their poise.
Growth stocks tend to be younger companies that derive their value from the rate at which they are expected to grow their earnings in the future. Generally, they pay limited dividends as they reinvest their profits to grow their businesses.
Value stocks tend to be well-established, mature businesses. They are companies whose share price is low relative to their underlying value. Consequently, ‘value stocks’ are among those with the highest dividend yields.
Small-/mid-/large-/mega-cap refers to the market capitalisation (market cap) or size of a given stock. This is literally its size as a company based on the total value of all the shares it has issued.
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Without downplaying the other general and presidential elections around the world in 2024, it’s hard to see any that will have more impact on the global economy than the upcoming presidential, Senate (where 34 of the 100 seats are up for grabs), and House of Representatives elections in the US. In the Senate race, 23 of the 34 seats up for election are sitting Democrats or independents. With the Republicans currently holding 49 of the 100 seats, they only need to ‘flip’ two seats to take control of the Senate. This is important because if one party has full control of both the legislative and the executive branches, it can implement its policies with considerably less resistance.
Geopolitics: Economics, and the election cycle
Racing to stand still
At the end of 2023, former President Trump was significantly ahead in the polls for the Republican party nomination, but this may change as other runners drop out and voter support coalesces around any alternatives. Meanwhile, we’ve yet to learn if the Democrats will break with tradition and elect not to nominate the incumbent – 81-year-old President Biden. It’s hard to see a re-elected Trump being a stabilising factor. His last administration pumped protectionism, promoted deregulation, reduced taxation, and targeted public spending. While defence will be a natural beneficiary of a second Trump administration, President Trump has very different friends compared to the current administration, which could have significant consequences for global stability. Meanwhile, it’s asking a lot for the Democrats to take the House, keep the Senate, and win the presidency. With a potential split in the legislature, or even a White House versus the rest scenario, it will be very difficult for President Biden, should he be re-elected, to push his agenda of greater healthcare spending, childcare, and climate-change policies, fuelled by greater taxation. It’s rare that the initial noise from an election result carries through to a significant shift in market direction. However, a major shift in policy and the impact it might have on economic activity, inflation, sentiment, and the stability offered by the US as a safe haven, could affect the prices paid by those investing in the US.
Trump top
Credit: lev radin/shutterstock.com
The same dynamic applies to the coming UK election as we wait to see if the Conservatives can recover enough in the opinion polls to call an early election, or if they let the clock run down and delay the ballot until January 2025.
Closer to home
Most likely outcomes for US equities in 2024
Nick Clay
Next article
A cleansing of the sores associated with Brexit would greatly improve future trade relations and bring a potential boost to both sides of the Channel.
It will be interesting to see if Labour’s resurgence is due to Keir Starmer’s drive to bring the Labour party back to the centre-left, or simply voter dissatisfaction with the current state of the country. One area that could benefit from a change in control is the UK’s relationship with Europe. This needn’t be a full re-entry to the EU. A cleansing of the sores associated with Brexit would greatly improve future trade relations and bring a potential boost to both sides of the Channel.
The results of both the US and UK elections will impact social, economic and global relations but they are unlikely to have a long-term impact on investment markets, providing that the rule of law is upheld, institutions remain stable and responses to global events are predictable.
China’s economic problems have undermined the performance of emerging markets equities in recent years while US interest rates are at record highs, which will further restrain them. Sacha Chorley explains why there’s more to the picture.
For even the most casual China observer, the weakness of the world’s second-largest economy has been striking. Given the size of China in emerging market indices and its importance as a trading partner, it’s not surprising emerging markets have trailed their developed counterparts.
Emerging markets: When will they catch up?
Positive shift in China policy
Chinese economic growth is stuck in a rut
Source: Quilter Investors and Bloomberg. Economic growth (gross domestic product) forecasts for China and the United States over period 21 January 2022 to 4 December 2023.
China’s recent economic woes stem from a combination of its imploding real-estate market that has triggered the failure of some of its largest listed property developers, the reduced levels of consumer activity this has helped to bring about, and the renewed geopolitical tensions with the US. However, a recent shift in Chinese government policy has been more supportive and suggests the tide may be turning. Since the summer, we’ve seen China’s policymakers implement a RMB1trn (c. £112bn) two-year infrastructure spending spree. This comes on the back of support for the housing sector that includes additional financing for property developers alongside consumer-facing initiatives such as encouraging banks to reduce mortgage re-financing rates. This is important as the property sector is a far more significant driver of China’s economy than those elsewhere. Around 44% of China’s household wealth is held in fixed assets (by far the greatest part of which is real-estate holdings). This compares to only around 27% of US household wealth. This means these measures could have a substantial impact on sentiment in China as they offer the potential for the real-estate sector, and by extension the consumer, to find their feet once again.
Where the wealth is kept
Source: Quilter Investors and Macrobond. China National Balance Sheet and US Federal Reserve Distributional Financial Accounts over period 1 January 2000 to 1 January 2019.
It’s always difficult to get an accurate read on geopolitical currents with meetings held behind closed doors, but Chinese/US tensions appear to be easing as the frequency of high-level talks between the two has grown. November announcements regarding reduced Chinese fentanyl production, the supply of which has greatly exacerbated the US opioid crisis, and joint statements on military matters also point to a thawing in relations. The strained relationship had been a major concern for global investors, so improvements here could also boost the market.
Tempers fraying
China’s domestic issues are only one facet of the emerging market question. Chinese stocks account for 30% of the emerging markets equity market with India, Taiwan, Korea, Brazil, and Saudi Arabia collectively accounting for 50%. All of these economies are expected to substantially outperform their developed market counterparts in the coming years, which translates into higher expected long-term earnings growth for emerging market stocks. This is supported by structural trends such as improving GDP per capita and the broadening of financial markets. Currently, emerging markets stock market prices are implying a limited expectation of economic growth, which is reflected by low valuations. By comparing the P/E ratio we can compare value across markets. At the end of 2023, emerging markets equities were trading at 12 times earnings, making it one of the cheapest regions at a time when global developed equities were trading at more than 20 times earnings. Although history never repeats itself, the current valuation picture for emerging markets is much like it was throughout 2015 and 2016. A period followed by two years of emerging markets substantially outperforming.
The price is right!
While the outlook for emerging markets is improving, now is not the time to jump in with both feet. Sensible investors will need to see signs that China’s latest policy measures have the desired impacts on consumer sentiment and economic activity. Similarly, while the long-term structural trends for local companies are appealing, investors also need to be mindful of nearer-term dynamics. So far, emerging market countries have seen less earnings growth than global equities and, until this improves, investors will be reluctant to increase their exposure to emerging markets. All of which suggests that, while the case for greater emerging markets exposure is building, we’re still at the very early stages of any recovery, awaiting more concrete evidence of improvement.
Potential clouds on the horizon
Emerging markets and the influence of the US
Head of Total Emerging Markets, Allspring
Alison Shimada
"Historically, both rising US interest rates and the strengthening US dollar that results, have presented a significant hurdle for emerging markets. However, despite lockdown and re-opening, and the high interest rates and surging dollar that followed, we haven’t seen the systemic risk and banking crises of prior cycles. This is because major emerging market economies such as India, Indonesia, and Brazil are now more resilient than they once were with both Brazil and India, among others, poised to reduce interest rates, perhaps even ahead of the US. Meanwhile, one of the most important geopolitical relationships in the world, that of the US and China, looks to be thawing after two years in the deep freeze. Going forward, we need to see a bigger move from China’s government to tackle local government debt and the real-estate sector, which could take time given the complexity of the issues. As it leads emerging markets, improving sentiment toward China will boost sentiment toward the asset class as a whole. Last year saw a significant dispersion of returns across emerging market countries and we expect to see this repeated in 2024. However, China, with its list of economic problems, will not be a leader. Instead, we expect market leadership to come from the likes of Taiwan and South Korea, which bounced back last year due to a recovery in semiconductor demand. India also outperformed other emerging markets in 2023 and we expect similar strong performance this year. Elsewhere, low valuations and strong shareholder returns in Brazil also have a good chance of continuing in 2024."
What do record US interest rates and a robust dollar mean for the outlook for emerging markets?
Economic growth forecasts for China and the US.
Chinese and US household wealth held in fixed assets (including real estate).
GDP per capita is a metric that breaks down a country's GDP (the monetary value of goods and services produced by a country) by dividing the GDP of a country by its population.
The price-to-earnings ratio (P/E ratio) provides a valuation for a company, a sector, or a market by dividing its current share price by its earnings per share (EPS).
For the last two decades, asset allocation within multi-asset portfolios has been built around the negative correlation between equity and bond returns. This meant bonds acted as a buffer during equity downturns, helping to stabilise portfolio returns. This relationship relied on low and stable inflation, but a combination of supply-chain blockages, overzealous fiscal policy, and the energy price spike triggered by Russia’s invasion of Ukraine, sent inflation soaring. This resulted in rapid interest-rate hikes that succeeded in turning one of the founding principles of asset allocation on its head.
Fixed income: A renaissance on the horizon?
The story so far…
Over a multi-year investment horizon, the best estimate of the likely return from a bond will be its yield when you bought it. Because the yields on bonds are now so much higher than a few years ago, the long-run expected return for bond investors is much higher too. Today’s higher starting point for bond yields also provides room for yields to fall (and bond prices to rise) when interest rates are eventually cut. This means that if inflation continues to moderate, which is likely given the slowing economy, bonds can once again provide downside defence in a multi-asset portfolio by making gains when equities decline.
What this means
Source: Bloomberg and Quilter Investors. Correlation of the MSCI USA Index and the Bloomberg Global Aggregate Government - Treasuries Index in US dollars over period 30 November 1990 to 31 October 2023. 0 means there is no correlation, 1 means there is perfect positive correlation, and -1 means there is a perfect negative correlation.
While interest rates remain high, it also appears as if cash investors are being paid to wait. However, they’ll see their returns fall when rates are cut, but without the price rises enjoyed by bondholders. This is one of many reasons why prolonged exposure to cash is typically a drag on returns.
The cash trap
We expect the next decade to be one of both higher interest rates and higher inflation than we became used to in the last decade.
How we see the future
There are a few factors opposing this moderately bullish view on bonds. Fiscal deficits are worryingly elevated and government debt piles have increased enormously as a result of covid support packages. Sensible fiscal policy dictates that spending should be cut or taxes increased in the good times so the reverse can happen in the bad. However, neither really took place during the post-lockdown economic rebound. This means governments have little room to increase spending into a downturn, and if they do, it will require them to issue even more government bonds. Given the worsening debt positions of many governments, there are questions as to whether investors in developed market bonds will demand still higher yields to finance this borrowing.
Headwinds persist
The negative correlation between bonds and equities broke down when inflation rose
Correlation between US equities and US government bonds.
Source: IMF Global Debt Database, September 2023. US and UK central government debt as percentage of GDP over period 31 December 1980 to 31 December 2028. Future values are estimates.
Government debt is on an unsustainable path higher unless spending can be reined in
Another fly in the ointment is that each central bank is tightening the purse strings differently as they try to normalise monetary policy. The Bank of England is actively selling the gilts it acquired during quantitative easing, while the US Federal Reserve is taking a more gradual approach by scaling down the portion of proceeds from maturing bonds that it uses to purchase new ones. Less bond buying from central banks has the potential to push bond yields higher.
Belts tightening
We had expected central banks to stick to their higher for longer narrative for some months yet, for fear of prematurely easing financial conditions and jeopardising the return of inflation to their 2% targets. However, the Fed’s pivot late last year meant the bond rally was brought forward in time as even more interest-rate cuts were pencilled in.
The end of higher for longer…
Interest rate cuts and the bond market
Head of Fixed Income
Lloyd Harris
Fiscal policy is the use of government spending and taxation to influence the economy.
Negative correlation is a relationship between two assets in which one asset increases as the other decreases, and vice versa. For example, when equity markets fall, bond prices rise.
Yield is a measure of the income an investment delivers. It is calculated as a percentage of either the original purchase price or the changing price of the asset in question.
UK and US government debt as percentage of GDP.
Quantitative easing is a monetary policy strategy where a central bank purchases securities in an attempt to reduce interest rates, increase the supply of money, and drive more lending to consumers and businesses.
While the impact of higher interest rates has yet to fully play out and further economic slowdown is likely, market pricing of rate cuts has now run well ahead of Fed projections. There is a risk of disappointment if these are not delivered as quickly as hoped, which could happen if growth doesn’t weaken enough or the fall in inflation slows. So while the softening economic backdrop looks like a positive one for bonds and we expect to see a shallow rally in 2024, the path ahead continues to look bumpy.
…perhaps not yet?
This should enable central bankers to take their feet off the brake pedal and deliver some interest-rate cuts this year. An environment like this should be positive for government bonds.
The effort to secure supply chains in the wake of pandemic and war-related disruptions is driving the onshoring of manufacturing in developed countries. This is inflationary – it costs more to make cars in the US than in Asia. Meanwhile, in economies with ageing populations and controlled immigration, supply constraints and robust demand could lead to inflation spikes. Nevertheless, we see room for a cyclical rally in bonds as growth and inflation continue to soften. This should enable central bankers to take their feet off the brake pedal and deliver some interest-rate cuts this year. An environment like this should be positive for government bonds.
While the impact of higher interest rates has yet to fully play out and further economic slowdown is likely, market pricing of rate cuts has now run well ahead of Fed projections. There is a risk of disappointment if these are not delivered as quickly as hoped, which could happen if growth doesn’t weaken enough or the fall in inflation slows.
The Magnificent Seven may have ridden to the rescue of equity markets in 2023, but, as Ian Jensen-Humphreys observes, there are far greater growth stories on offer from innovative companies that have yet to hit the headlines.
One of the most prominent market themes in 2023 was the rise of artificial intelligence or AI. According to its advocates, AI will radically transform our lives in much the same way as the advent of the internet. As such, companies in the AI sphere have seen impressively strong growth in sales and earnings which has led to stellar share price gains for some companies. This has been the driving force behind the rise of the Magnificent Seven – it was mainly their share price gains that drove US equity market performance in 2023. However, strong growth exists in many areas of the economy, not just huge US tech companies. Some good examples of such companies held by our underlying managers include: Roll over each box to find out more.
Growth opportunities: Unearthing hidden gems
Artificial gains
This California-based company designs, manufactures, and sells surgical systems and machines used during medical procedures. The company has tripled its revenues over the past 10 years. Intuitive’s da Vinci systems have already been used in robotic-assisted surgeries for more than two decades. This less invasive approach, called minimally invasive surgery, reduces recovery times and the chances of infection, resulting in patients spending less time in hospitals. Meanwhile, data from more than 10 million surgical procedures using da Vinci systems is being used by the company’s AI developers. The insights generated by a data-set of this size will greatly assist surgeons when it comes to identifying and addressing anomalies and potential complications. This is a great example of ‘non-tech’ companies benefitting from the application of AI. It also captures the long-term demographic tailwind provided by ageing populations that, inevitably, require more medical attention and more surgery than younger ones.
Intuitive
Premier Miton European Opportunities Fund
Alliance Bernstein International Health Care Portfolio
Engcon manufactures construction machinery equipment. One key growth area for its business is ‘tiltrotators’. These allow for the rotation of the buckets on diggers and excavators. Tiltrotators add an incremental upfront cost to the equipment, but they allow for much more efficient use of the machinery. This helps to reduce completion times and to lower labour costs. Currently, 95% of the diggers in Engcon’s home market of Sweden have these attachments, but just 1% of diggers worldwide can say the same. This clearly creates a huge growth opportunity over the coming years. As of late November 2023, the company’s shares had gained over 90% since its IPO in June 2022.
Engcon
Gamma is a provider of business-to-business communication solutions in the UK and Europe. It’s a great example of an under-the-radar, UK-based tech company. Gamma has an innovative portfolio of cloud-based, unified communications and internet-enabled telephony products and services. The business also delivers high levels of customer service in a marketplace where sheer complexity is frequently a major barrier to the adoption of new solutions. The company has very high levels of recurring revenue (the portion of its revenue that is expected to continue in the future) at around 90% of its turnover. This underpins a robust business model that has helped Gamma to triple its revenues over the past 10 years. With over half of the businesses in Gamma’s UK and European markets yet to fully embrace cloud-based communications solutions, there is a clear, long-term structural growth opportunity that remains ripe for the taking.
Gamma
Credit: Gamma
Liontrust UK Growth Fund
Credit: Engcon
Credit: Intuitive
The top US stock picks in 2023
Managing Director and Portfolio Manager, JP Morgan Asset Management
Felise Agranoff
“Last year, the US was all about the return of the mega-cap tech stocks. They came surging back in 2023 and accounted for a significant share of the total return from US equity markets.
What were your top US stocks picks in 2023 and why?
Feeling chatty
It was the launch of ChatGPT late in 2022 that lit the fuse for last year’s explosion of interest in all things AI-related. It showcased the breakthrough in generative AI by providing the first individual user access to the underlying ‘large language model’ that’s capable of answering complex questions and solving problems. The sudden availability of this technology is incredibly significant as it has the potential to replace many white-collar roles, including the writing of software code. Consequently, companies of all kinds are investing aggressively in AI as both as offensive weapon and as a means to defend their existing businesses. This delivered a stellar year for Nvidia. The company posted excellent numbers in 2023, with earnings revisions up more than 180% over the last year, reflecting that Nvidia’s graphic processing unit chips remain almost the only game in town for the time being. The arrival of AI also boosted a host of other US consumer and tech stocks this year including giants such as Meta (formerly Facebook) and Amazon. However, stocks across the market spectrum were also swept up in the excitement with the likes of Palo Alto Networks, Advanced Micro Devices, MongoDB (a software developer), Copart (an online vehicle auction and remarketing service), Uber, Lam Research, and Synopsys, both suppliers to the semiconductor industry, all making excellent progress in 2023.”
Managing Director and Portfolio Manager
One of the most prominent market themes in 2023 was the rise of artificial intelligence or AI.
Next company
Last year was not a good year for ‘consensus’ opinions as the widely anticipated global recession failed to materialise, despite sticky inflation and continued interest-rate hikes. So far, the UK economy has also been a lot more resilient than expected. UK household balance sheets, which have benefitted from the excess savings built up during lockdown, helped to cushion UK households against the rising prices of goods and services. Meanwhile, UK wages have also been rising in real terms, which has provided a buttress for UK consumer spending. However, a large proportion of UK homes have yet to feel the full impact of the historic rate-hiking cycle we’ve just lived through. This is something that will really start to bite in 2024.
UK equities: bargain-basement prices
Blissful ignorance
In years gone by, millions of Britons sensibly took advantage of the ultra-low interest rates to lock-in fixed mortgage rates. Recent data suggests that some four million UK mortgages will need to be re-financed over the next two years, in the current higher for longer era for interest rates in the UK. This will feed through into consumer sentiment at a time when UK spending is already embattled. Currently, UK retail sales remain below pre-lockdown levels in real terms, and this weakness will be increasingly exacerbated by the impact of higher interest rates.
Inflation is also still very much a concern. While the UK prime minister, Rishi Sunak, wasted no time in declaring victory on his 2023 priority of halving inflation UK year-on-year inflation fell from 10.5% in December 2022 to 3.9% in November 2023) this is still well above the Bank of England’s 2% inflation target. Bringing inflation down from current levels to 2% is also likely to be a much more difficult journey. The bank will be closely monitoring the UK labour market, looking for signs that employment is softening, and that wage growth is slowing – two key factors that keep a lid on inflation. There are tentative signs that this is underway, although wage growth remains at levels inconsistent with the bank’s 2% inflation target. It will also need to be mindful of any ill-timed tax giveaways by an ageing Conservative administration facing the prospect of a Labour clean sweep in the next general election. The Bank of England kept UK interest rates on pause for a third consecutive meeting in December and kept to its higher for longer narrative. It has little choice as inflation remains more persistent in the UK than elsewhere. However, the US Federal Reserve’s surprise pivot towards interest-rate cuts in December will only increase the pressure on the Bank of England to follow suit.
Don’t count your chickens
Despite this seemingly grey UK economic backdrop, there are several reasons to be positive on the outlook for the UK stock market. After years of underperforming their peers, UK equities now look cheap relative to both their own history and companies overseas. At the end of 2023, in terms of P/E ratios, the discount between the US equity market, which currently trades at around 24 times earnings, and the UK, languishing at 12 times earnings, was the highest it’s been this century. Meanwhile, the UK offers the highest dividend yield globally and is home to world-beating companies that derive a significant portion of their venues from overseas. This means they’re relatively insulated from ailing UK consumers. Therefore, if we see sterling weakness, it will provide a significant boost to UK company earnings and increase the attractiveness of UK equities for overseas investors who have generally steered clear in recent years. Also, due to its heavy exposure to commodities, energy, banking, utilities, and consumer staples stocks, the UK is the most value-biased regional equity market in the world. This makes it a largely defensive index, which could do well in a more difficult economic backdrop. In addition, the more domestically-focused UK mid-caps have fallen significantly since their highs of 2021. This valuation cushion should help to limit further downside if the economy continues to deteriorate, as much of this bad news already appears to be priced-in. This means that, despite the economic challenges, the UK stock market currently offers an opportunity to buy world-class companies at decade-low valuations.
Reasons to be cheerful
Inflation, elections and the outlook for the UK
Investment Manager
Adrian Frost
The price-to-earnings ratio (P/E ratio) provides a valuation for a company, a sector, or a market, by dividing its current share price by its earnings per share (EPS).
Consumer staples companies supply goods or services that are always in demand. Consequently, they are referred to as being ‘non-cyclical’ or ‘defensive’ companies and are favoured by investors when economic growth declines.
‘Value’ stocks have low share prices relative to their intrinsic value and tend to pay more generous dividends than growth stocks. ‘Growth’ stocks derive their value from the rate at which they’re expected to grow their future earnings.
Recent data suggests that some four million UK mortgages will need to be re-financed over the next two years, in the current higher for longer era for interest rates in the UK.
The UK is pushing back on some of its commitments to climate change and net-zero targets at a time when other countries are stepping up their efforts. Bethan Dixon provides an outlook for responsible investors who are understandably concerned.
In years gone by, cross-party consensus on climate change had helped the UK to become a global climate leader. Between 1990 and 2001, the UK decarbonised faster than all its G7 peers. It was the first to enshrine a net-zero target into law and is still among the world leaders in offshore wind.
Climate change: The UK risks losing momentum
Blowing hot: UK offshore wind capacity
Source: Global Wind Energy Council (GWEC) Market Intelligence June 2023.
It was a Labour government that passed the Climate Change Act 2008, which committed the UK to an 80% reduction in greenhouse gas emissions by 2050. Net-zero was subsequently enshrined in law by Theresa May's Conservative government in 2019. Then UK ambitions were raised once more by Boris Johnson’s government, when it announced an optimistic target for a 68% reduction in greenhouse gas emissions by 2030. However, less than a year into the job, the UK’s current prime minister, Rishi Sunak, announced a ‘new approach’ to climate change. This included pushing out the ban on the sale of petrol and diesel cars from 2030 to 2035. The policy U-turn was framed as an honest approach to net-zero which alleviated “unacceptable costs from hard-working British people”. Inevitably, many saw the move as politically motivated. Watering down the country’s climate ambitions to appeal to UK households struggling with the cost of living while creating a clear political divide from the Labour Party, which has expansive green spending plans ahead of the next election.
Missing the boat…
Even before the latest policy reversal, the UK’s Climate Change Committee, which monitors the government’s progress on climate change, had expressed concerns. Chief among these was that those policies the committee viewed as ‘credible’ were only sufficient to secure around 20% of the promised emissions reduction over the next decade.
Lost in committee
China
48.9%
UK
21.6%
Germany
12.5%
Netherlands
4.4%
Denmark
3.6%
Others
9.0%
Total offshore wind installations by market.
The make-up of the UK equity market (heavy in oil, gas, and mining stocks but light on technology and innovation) exposes investors to more ‘transition risks’ – namely the costs that come with transitioning to a low-carbon economy – than most other markets. Meanwhile, the UK’s latest policy changes have provoked some major companies to publicly express their frustration. As Ford’s UK chief, Lisa Brankin commented, “[Ford] needs three things from the UK government: ambition, commitment and consistency. A relaxation of 2030 would undermine all three.”
The outlook for UK investors
Rather chillingly, on 17 November 2023, the global average temperature rise above pre-industrial levels breached two degrees Celsius for the first time in history. This is the threshold at which, if we see temperatures sustained, scientists predict a climate catastrophe. This is a stark reminder that society must act now. While there may be signs the UK government is losing momentum on climate change, this isn’t necessarily a reflection of the ambition of UK companies. Compared to other equity markets, the UK is a relatively good hunting ground for companies that have made formal, science-based climate commitments, with 56% of the market having approved or committed to science-based targets. So, while the fight against climate change in 2023 has been disappointing from a political standpoint, UK investors can still take action through the companies in which they invest.
Too hot to handle…
Basing it on science
Source: FactSet, MSCI. Data provided by ISS ESG. Index holdings data as at 31 October 2023.
Percentage of equity market with science-based climate commitments.
Back to start
...the [UK’s] forward momentum on climate change is at risk of stuttering at a time when many other countries are stepping up their ambitions.
While the UK has so far made good progress compared to other countries in decarbonising, the forward momentum on climate change is at risk of stuttering at a time when many other countries are stepping up their ambitions. The Inflation Reduction Act, signed into US law in August 2022, has been recognised as the most ambitious piece of climate legislation ever implemented. Meanwhile in Europe, the RePower EU plan aims to fast-forward the region’s transition to renewables and to end its reliance on Russian fossil fuels by 2030.
