Has the tide turned for UK equity income in 2024?
In the dim and distant 2000s, UK equity income was the hot sector. Home to a raft of star manager...
For much of 2023, there has only been one game in town: technology. Or more specifically, artificial intelligence.
Investors have generally been too worried about inflation, higher interest rates and economic stagnation to look elsewhere. In November, however, stock markets turned. Investors now need to decide whether this is a flash in the pan or the start of something more sustained?
In many respects, the signs aren’t promising for the stock market in the year ahead. The consensus among economists is for an economic slowdown, with the lag effect from interest rates hikes weighing on growth. The pandemic savings that have sustained consumers around the world are running low, while businesses across the world are navigating shifting supply chains and lingering inflationary pressures.
Andrew McCaffery, Global CIO, Fidelity International, says “markets are currently lined up behind a ‘soft landing’ where the rate hikes and the tightening of the past two years will do just enough to gradually return the economy and labour market to equilibrium.” However, he believes recessionary pressures will build during the year, as debt is refinanced, and pandemic savings run out. “A moderate recession is likely to be the final outcome of this cycle.”
Andrew highlights another headwind for markets in the year ahead: elections. He says: “There will be an exceptional run of elections across the world during 2024 coinciding with a renewed interest in fiscal policy alongside the future direction of restrictive monetary policy. The world is always uncertain. But this is one of those periods when it is not an exaggeration to use the phrase ‘regime change’. Investors will need to stay nimble in 2024, ready to navigate each twist and turn.”
That said, in the recent Bank of America Merrill Lynch fund managers’ survey, 75% of those polled see a soft landing* or no landing as the most likely outcome for the US economy. It may be that with inflationary pressures easing, some easing of borrowing costs and a mild recession, good companies can still make progress in the year ahead.
Equally, the economy is not the stock market and many believe the turning point could come just as recessionary pressures peak.
James Thomson, manager of the Rathbone Global Opportunities fund says: “We believe that a confirmed earnings recession could be the final concession that drives a new bull market…The recession fear will open the door to rate cuts and the start of a new cycle. But this broad stock market rally won’t be enjoyed by many investors who have been hiding in cash waiting for the perfect moment. By the time investors know that the worst of the recession is behind them, the stock market has already made its move.”
With the exception of the US technology sector, valuations across the major markets do not look demanding and, in the case of the UK and China, look cheap. With more certainty on interest rates and inflation, and an answer on recession, it may be that stock markets can find their footing once again.
The recent market rally has been a taster for any potential rise in stock markets in the year ahead. The strongest areas over the past month have been those hit hardest by rate rises: property, financials, healthcare, infrastructure and smaller companies. It has demonstrated that there are buyers on the sidelines willing to jump in if inflation appears to be under control and the damage to the economy only moderate.
Technology has been the stand-out winner of 2023 and has become the default solution for all market conditions. It is defensive in tough markets, while providing growth in rising markets. Against a complex and difficult backdrop, investors have continued to direct capital to high profile companies that are still growing earnings. Artificial intelligence has given the megacaps another string to their bow.
It is not clear that this will continue into 2024. They are now notably more expensive than similar companies in other countries, as well as a number of US peers.
Bob Kaynor, manager of Schroder US Mid Cap, says: “One of the dynamics we’ve seen this year is that global allocators don’t feel like there’s a lot of opportunities in equities so they end up buying the MSCI All Countries World Index (ACWI). There’s a view that somehow this is a diversified benchmark when in fact almost 20% of the ACWI is in those same seven stocks.”
When investors are more confident, it could push money away from the index and away from these stocks. He added in a recent podcast interview: “The ‘Magnificent Seven’ are expensive, they’re crowded – what causes allocators or investors to move away ultimately will come down to better opportunities elsewhere.” His view is that these opportunities will emerge in the year ahead.
China has been 2023’s unloved spot, with the average fund down 20.7% for the year-to-date**, having dropped 16% in 2022***, and 10.7% in 2021. The question for 2024 is whether the country has now reached capitulation point?
Investors are eagerly hoping for a big announcement on stimulus packages from the Chinese government. It has been wary of these moves – believing that excessive stimulus directly contributed to the housing bubble – but with deflationary pressures mounting, it may feel compelled to take action. The Chinese market is cheap, and could turn sharply if investors started to believe in the economic growth story once again.
The UK, cheap and unloved, may also be ripe for a reappraisal. There has been some stabilisation on the economy and in its wayward politics. Many UK companies are operationally sound and using spare cash to pay dividends and fund share buybacks. The small and mid-cap sector, in particular, looks compelling value.
Nick Shenton, co-manager of the Artemis Income fund, says: “You’ve got to be in it to win it because when this market starts to rerate and attracts outside capital, we think shares could move quite significantly and it will be too late to try and play spot that trend and buy it. There are a lot of companies trading on single digit PEs in the UK. These are really big, good businesses. There is a buyer in town and that is the companies themselves. So there’s another two and a half percent return from buybacks.”
Europe also has opportunities, says Samantha Gleave, co-manager of Liontrust European Dynamic fund. She gives the example of healthcare giant Novo Nordisk. “It has a very large market share in the treatment of diabetes. Recently they’ve developed a weight loss drug where growth prospects are very high, not just in Europe but also in other markets such as the US.”
Healthcare is a key area to watch in the year ahead. Progress on hard-to-abate conditions such as obesity and Alzheimer’s could be as significant as AI in its influence on capital markets in the year ahead. Healthcare has struggled with its reputation as a slow growth, interest-rate sensitive industry, but this could restore structural growth dynamics.
The year ahead is not clear-cut. In many cases, equity markets still have value, but a weakening economic backdrop and refinancing costs may dent company earnings. In the absence of central bank bazookas, it will be a year where skilled stockpickers will need to navigate markets carefully.
*Source: Portfolio Adviser, 5 December 2023
**Source: FE Analytics, total returns in sterling, 1 January 2023 to 13 December 2023
***Source: FE Analytics, total returns in sterling, 1 January 2022 to 31 December 2022
****Source: FE Analytics, total returns in sterling, 1 January 2021 to 31 December 2021