- Pessimism from 2022 gives way to optimism as markets look for peak in inflation and interest rates
- Index’s exposure to oils, banks, miners and insurers, and the absence of tech, currently helping rather than hindering
- UK equities look cheap on an earnings and yield basis
“’Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria,’ argued fund management legend Sir John Templeton, and there may be no better example of that right now that the FTSE 100 and the UK equity market,” says AJ Bell investment director Russ Mould. “The dominant theme now seems to be that ‘better times are coming,’ especially after the share price crushings handed out to a lot of cyclicals and consumer discretionary names in the first half of 2022 may have left them looking cheap, while the index’s exposure to miners and oils may also give the FTSE 100 appeal as a potential inflation hedge for good measure.
“The UK’s benchmark index is trading at a new all-time high as it prepares to celebrate its fortieth birthday in January 2024. The key themes which seem to be underpinning the FTSE 100’s upward march include:
- Analysts have already slashed earnings estimates and share prices have fallen sharply already, so it is easier to argue that a lot of bad news and the threat of a recession is already priced in.
- Lower oil prices, a mild winter and energy subsidies/price caps are helping take some of the pressure off consumers, while wages are still rising.
- Hopes that the rate of inflation has peaked, helped by lower oil and gas prices, and that it will continue to decelerate.
- This will in turn give the Bank of England chance to halt its cycle of interest rate increases and pivot to rate cuts. The yield on the two-year UK government bond, or gilt, is arguing precisely this. It traditionally leads the Bank of England base rate by six to nine months, and it is sat at 3.75%, below the 4% base rate, even though the Bank of England is hinting at a peak in rates of 4.5% by the middle of this year.
“In sum, the message is that, ‘it will all get better.’ Given that view, it is not difficult to argue that the FTSE 100 represents decent value, on a price/earnings ratio of barely 11 times with a yield of 4%, according to aggregate consensus analysts’ forecasts for 2023, especially to overseas investors who get the additional benefit of a cheap currency – sterling is still yet to recapture the ground it lost against the dollar and the euro in the immediate aftermath of 2016’s vote on EU membership.
“A lot of the news today still seems bad. But markets are saying that was priced in during 2022’s heavy mid-year falls, and the bad news is known. The bear case always looks most compelling at the bottom and there is an old saying that ‘you can have cheap shares and good news, just not both at the same time.’
“No-one has seemed interested in the UK equity market for ages, other than to bash it for failing to attract more new flotations and temporarily losing its status as Europe’s largest arena by market cap to France.
“Such knocking copy persists, even though analysts think the FTSE 100’s aggregate pre-tax income in 2023 will exceed that of 2017 by 71% and that dividend payments will set a new all-time high and come in 6% above 2017, when the index reached what was then its closing high of 7,877, back when Theresa May was still Prime Minister.
Source: Company accounts, Marketscreener, consensus analysts’ forecasts
“Corporate confidence also seems high, judging by how the FTSE 100’s members announced a record £55 billion in share buybacks in 2022, to add to £2.8 billion in special dividends already paid and analysts’ forecasts of £79.1 billion in dividend payments. Combined, that lot makes a cash yield on the FTSE 100 of 6.4% for 2022.
Source: Company accounts, Marketscreener, consensus analysts’ forecasts
“Even if there is no guarantee of a repeat in 2023, dividend cover is at its highest point since 2012 and forecasts of a 4% dividend yield combined with a forward price/earnings ratio of barely 11 times may catch the eye of value-seekers.
Source: Company accounts, Marketscreener, consensus analysts’ forecasts
“It is possible to argue that the UK stock market is cheap because it deserves to be, given the FTSE 100’s heavy weightings toward the unpredictable (oils and miners), the indigestible (banks and insurers) and the beyond-the-pale, at least so far as ESG screens are concerned (tobacco, oils, miners, bookmakers and defence stocks).
“Yet the valuation is tempting and certain sectors – banks, miners, housebuilders – already look to be pricing in a downturn in earnings and a recession, looking at their valuations and analysts’ predictions for the trajectory of their earnings. Yes, aggregate earnings forecasts for earnings and dividends in 2023 could be too high, especially if any recession is a deep one, but the market seems to be ahead of analysts in terms of pricing that in.
Source: Company accounts, Marketscreener, consensus analysts’ forecasts
“A recession may not a big surprise now, at least from a share price perspective, and if we get an alternative outcome – such as stagflation, inflation and stickier-than-expected interest rates – the UK equity market’s charms may become more apparent.
“Admittedly, consensus forecast earnings growth of 10% for 2023, alongside 9% dividend growth, may not set everyone’s pulse racing. But there is the potential for upside to those estimates, especially as the slant of earnings towards oils, miners and banks means the FTSE 100 may be one of the indices that is better suited to an inflationary or stagflationary out-turn which could mean interest rates stay a bit higher for a bit longer than expected and that the yield curve turns out steeper than expected.
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Percentage by sector for total FTSE 100, 2023E consensus forecasts |
||||
|
|
Pre-tax profit |
|
|
Dividends |
|
Oil & Gas |
24% |
|
Financials |
23% |
|
Financials |
23% |
|
Consumer Staples |
18% |
|
Mining |
16% |
|
Mining |
16% |
|
Consumer Staples |
12% |
|
Oil & Gas |
12% |
|
Industrial goods & services |
7% |
|
Health Care |
8% |
|
Health Care |
6% |
|
Industrial goods & services |
8% |
|
Consumer Discretionary |
5% |
|
Consumer Discretionary |
6% |
|
Utilities |
3% |
|
Utilities |
4% |
|
Telecoms |
3% |
|
Telecoms |
4% |
|
Real estate |
1% |
|
Real estate |
1% |
|
Technology |
0% |
|
Technology |
0% |
Source: Marketscreener, consensus analysts’ forecasts
“That would again contrast with markets like the USA, which is packed with tech, social media, internet and biotech stocks that offer the prospect of long-term earnings growth from the starting point of high valuation multiples. The package remains one of jam tomorrow at high prices, a combination which proved ill-suited to 2022’s environment – an environment which investors believe to be the aberration rather than the new normal.
“But what if a 40-year period of cheap money, cheap energy, cheap labour and cheap goods is coming to an end?
“Equities are rallying and commodities lagging, in a direct reversal of 2022’s prevailing trends, owing to the narratives that only a shallow recession is coming and that rate cuts will follow as inflation eases. But should inflation – or stagflation – prevail, commodities and ‘real’ assets could yet exert a stronger pull than ‘paper’ ones and although commodities have outperformed for the last two years, their relative strength compared to equities is nowhere near as great as it was during 2008-10 when faith in paper assets and central banks was also at a low ebb.”
Source: Refinitiv data
