Can UK equities maintain their early year outperformance?
UK stocks have outperformed European stocks so far this year and posted their best performance against US stocks since 2015.
The Morgan Stanley Capital International (MSCI) UK (GBP) index closed last week up 3.2% from the end of 2021, compared to the MSCI USA (USD) index, down 9 .9%, and the MSCI Europe ex UK index. , down 4.9%.
Meanwhile, the FTSE 100 is down 0.40% year-to-date, ahead of the S&P 100 (down 6.79%) and the EURO STOXX 50 (down 3.65% ), although the UK stock market still had its worst January since 2016.
“So far, UK equities have been spared risk aversion sentiment in financial markets, driven by changing expectations for central bank policies,” said Samuel Tombs, Britain’s chief economist. at Pantheon Macroeconomics, in a note highlighting the numbers.
Equities helped by interest rate expectations
A rising interest rate environment is more problematic for technology companies and growth stocks, which derive much of their value from projected future cash flows, which are weaker when rates are higher. .
“Tech stocks make up a tiny 1.4% share of the UK index, compared to 29.9% of the US index. This means that UK stocks tend to do relatively well when interest rate expectations are rising,” Tombs said.
Inflationary pressure is currently stronger in the US than in the UK or Europe, with analysts expecting between three and four rate hikes by the Federal Reserve this year. Between two and three rate hikes are planned by the Bank of England (BoE), while the European Central Bank (ECB) remains silent on any rate hike plans.
It also saw European equity funds start 2022 with their highest inflows at the start of the year since 2018, with financial companies recording the largest inflows. Indeed, as Tombs stated, “Banks find it easier to make profits when the yield curve steepens, since they typically borrow short and lend [on a] long term [one].”
Finance companies take advantage
The situation is proving to be another tailwind for the UK, where financials make up 17.4% of the index, compared to 10.5% in the US.
Additionally, based on an analysis of 12-month forward price-earnings ratios, Tombs believes that the risk premium embedded in UK equities appears to have declined this year, which he believes is a sign of a “positive change in attitude towards Britain”. as a place of investment.
Will the outperformance of the United Kingdom continue?
Looking ahead to the rest of the year, Tombs don’t think the UK’s current lead will continue. “Our view that interest rate expectations have risen too much – we are expecting a 50 basis point rise in the bank rate this year, half of that priced in by the markets – suggests that financial stocks will now struggle.
“As a result, we expect the FTSE 100 to rise only slightly to around 7,600 by the end of this year, below the rise in the S&P 500, which is expected to end 2022 around the 5,000 mark. .” He also noted that over the past six years, the MSCI UK index has risen 7% against increases of 40% in Europe and 112% in the United States.
However, in the shorter term, Laura Hoy, equity analyst at Hargreaves Lansdown, believes that “commodities and financials seem well placed to continue their upward march”.
Hoy added: “These sectors are also linked to economic growth, so their recovery will be short-lived if tighter monetary policy strangles the post-pandemic recovery.
“The tech set could be poised for a comeback if rate concerns prove overdone, but for now the FTSE should continue to beat its US peer as the rotation from growth to value continues. “
Stocks to Watch
“[Currently]commodity heavyweights are tipping the scales in favor of the FTSE, particularly when it comes to oil companies like BP and Shell (RDS), which have benefited from soaring oil prices and geopolitical uncertainty,” Hoy said.
Wall Street analysts’ consensus one-year BP share price target is £456.88, according to MarketBeat data, up 18% from today – although Wallet Investor based on one algorithm, although currently bullish, predicts a drop over the year, with a closing price of £307.329 expected in December 2022.
MarketBeat also sees Shell gain this year, with the stock rated “buy” based on 11 analyst ratings. The company will undergo a restructuring that will see it move from a double-share structure to a single-share structure with the aim of increasing returns for investors.
Meanwhile, “big banks like Lloyds are poised to see higher profits if the BoE continues to raise interest rates,” Hoy added.
Lloyds has been named by Hargreaves Lansdown as one of its top stocks to watch this year, with the company citing its “abundance of excess capital, possible interest rate hikes and growth opportunities” due to its low ratio cost/revenue and its cost. savings.
Hoys’ stocks to watch mirror the predictions of fellow analyst Ian Stokes, managing director of corporate markets UK and Europe at financial data firm Link Group, who predicts that in a market where investors will seek income , “banks and oil companies should be the main drivers of progress in 2022” for dividends.
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