In the face of today’s global economic challenges, the United Kingdom finds itself in ‘ugly’ straits, grappling with some alarming statistics. It currently leads major economies with an inflation rate exceeding 8% and contends with some of the highest interest rates. The outlook for growth appears tepid for the coming years, and the performance of the FTSE 100 index has been rather lackluster compared to its international counterparts. However, amid the doom and gloom, a unique opportunity may be emerging for proficient investors who can look beyond the surface.
One of the positive aspects that makes the UK an intriguing opportunity for investors lies in the fact that FTSE 100 companies generate a substantial 80% of their earnings from outside the country. As a result, they are not solely reliant on the domestic economy, providing a level of insulation from local economic woes.
In addition, the valuations of UK companies are currently trading at around a 20% discount to global peers, presenting an enticing opportunity for growth.
Charles Luke, an investment manager at Murray Income Trust, said in a June 28 report that the UK market is relatively “cheap” both in absolute terms and compared to its historical performance and global equities. This phenomenon essentially allows investors to obtain global income at a knockdown price.
The combination of attractive valuations and the potential for earnings growth outside the UK could be a compelling proposition for those willing to take calculated risks.
An analysis of the sector composition of the UK market further supports this notion. While the US market has been largely driven by the technology sector, the FTSE 100 boasts a higher concentration of financial companies. These financial firms stand to benefit from the surge in interest rates, offering investors a unique opportunity in the second half of the year.
Despite the current high inflation in the UK, 7.90% for June, there are signs that it may begin to decline soon, following the trend observed in the US and other countries. The drop in inflation, from 8.70% on May 31, could have favorable implications for certain consumer staple stocks, such as Diageo and Unilever.
Both companies have faced challenges this year, with Diageo reporting slowing growth in North America and Unilever experiencing a slight decline since the beginning of the year. However, analysts still see potential, with Diageo having an average 11% upside in target price and Unilever showing an 8.2% implied upside.
The projected fall in inflation also bodes well for travel-related stocks, including International Consolidated Airlines (IAG). Although IAG has seen a 27% increase in its share price this year, it still lags behind its US rivals, American Airlines and United, which have experienced gains of more than 45%. This lag in price growth may present an opportunity for investors, especially if inflation continues to decline.
Meanwehile, energy giants Shell and BP, while performing similarly to their peers, present a value investment opportunity. Their shares currently trade at a significant discount compared to Exxon, the largest US oil producer.
BP trades at 6.4 times forward earnings, Shell is at 7.5 times. Exxon, the biggest U.S. oil producer, is trading at 11 times earnings by comparison.
Falling oil prices have obviously impacted BP’s stock performance, however, the company has beaten analyst estimates for profitability, promising disciplined investments, reduced debt, and increased distributions to shareholders. As the energy sector continues to evolve, these stocks could become even more attractive.
While the UK faces economic challenges resulting from various factors, such as a tight labor market and energy price volatility, it is worth noting that its current predicament presents an intriguing opportunity for investors. The lingering impacts of Brexit and the government’s fiscal policies have also contributed to the uncertainty. The equity market, however, shows potential for growth even as economic growth prospects remain subdued.
barrons.com quoted J.P. Morgan’s global market strategist, Hugh Gimber, as saying that the U.K. economic outlook is more challenging than other parts of the world.
“But the equity market could actually stand to benefit,” Gimber added.
This sentiment aligns with the notion that there are hidden opportunities for growth and earnings within the UK market.
In light of the prevailing headwinds and negative economic indicators in the British economy, the underperformance of the FTSE 100 presents a distinctive potential for capable investors. The significant proportion of earnings from outside the UK and the attractive valuations of UK companies provide an opportunity for growth. Investors with a long-term perspective and a discerning eye for value investments could find the UK market an appealing destination. By considering the potential growth in the financial sector, consumer staple stocks, travel-related companies, and energy giants, skilled investors may be able to capitalize on the market’s current undervalued status.
