In this analysis, Ben Needham, portfolio manager in Ninety One‘s Quality team, is looking ahead to the first BoE interest rate decision of the year, and what it means for UK equities in 2024.
UK equities should not be feared
“Since 2016 we have had Brexit, a pandemic, a free money stimulated bull market, rampant inflation, a record-breaking pace of interest rate increases, a local conflict in Europe, a property crash in China, a local conflict in the Middle East, and a Tory government changing their leadership a remarkable four times. Leicester City also managed to win the Premier League title, but now find themselves in the Championship. In this context, when predicting the direction of travel for interest rates and/ or the UK economy we are minded to whisper, as opposed to shout. Our whisper is that rates remain on hold with the BoE essentially giving themselves time for the economic and inflation picture to become more transparent. The inflationary picture does appear to be improving in the UK but exogenous risks, such as the Red Sea related issues, cannot be dismissed.
“Despite the uncertain direction of travel for monetary policy and the economy, we do not believe UK Equities are something to fear as we ponder 2024 (and beyond). First, our observation is that many companies which have both domestic and economically sensitive earnings have experienced quite hefty downgrades and a derating on those earnings downgrades already. This should improve the probability for achieving attractive forward returns in the more cyclical corner of the UK market particularly if real incomes can continue to recover. Second, slower growth and/ or perhaps gloomier economic trends could well be a precursor for lower interest rates and therefore lower discount rates which can support PE multiples. This is not something we believe is a necessity for good forward returns but undoubtedly there is a tug of war currently taking place as the hope of lower discount rates pulls against the fear of recessionary induced earnings pressure. Finally, with potentially peak funding costs, multi-decade-low sterling (versus the dollar), a notable valuation discount (to MSCI world), forced pro-cyclical outflows from many UK mutual funds and every banker (and stakeholder linked to the city) thirsty for (trans)action(s), it is hard to argue against UK M&A being a significant upside risk. Ironically, it could transpire that institutional flows into private markets find their way to the UK public market. Certainly, as UK investors we cannot control the flow of money into our asset class, nor will we moan about it. However, we can try to ultimately benefit from any potential misallocation of capital and concurrent mispricing opportunities which we think are aplenty.”
