Quarterly Perspective: UK equities – worth a closer look?

Overview

The UK equity market got off to a strong start in 2015, growing by over 8 per cent by mid-April, driven by an improving outlook for global and European growth. However, a renewed fall in commodity prices has hurt the share prices of the basic materials and energy companies that make up 16 per cent of the FTSE All Share. Thanks to the summer sell-off, both the FTSE 100 and the FTSE All Share are now in the red year to date, providing an attractive entry point for investors who missed the earlier market rally.

The UK economy continues to pick up pace

The UK has recently been one of the best-performing developed market economies, with an average growth rate of 1.9 per cent year on year over the last 12 months – well above the G7 average of 1.1 per cent year on year. It was the fastest-growing economy in that group in 2014, when national output expanded by 2.6 per cent.

Such strong growth is beginning to pay off for UK workers, with wages now starting to rise after years of falling living standards. As shown in the bottom right-hand chart, UK wages have grown in real terms for the last nine months, the longest period of sustained real wage growth since the global financial crisis began in 2007.

The UK is experiencing the longest period of sustained real wage growth since the financial crisis.JPMGraph-3Focus on domestically oriented companies

In order to gain exposure to the economic recovery taking place in the UK, investors should consider moving down the market capitalisation spectrum towards small and mid cap companies. As shown by the bottom right-hand chart, a large proportion of the mega cap FTSE 100 is made up of sectors such as basic materials, energy and financials. All of these sectors have global exposure and source very little of their revenue in the UK economy.

In contrast, as the top right-hand chart shows on slide 37 of Guide to the Markets – UK, smaller UK companies have more exposure to the UK than the global economy.

The valuations argument for UK equities is also compelling. The overall composite valuation of UK equities is below that of the global index. For investors seeking income, the UK is also an attractive opportunity. UK equities currently have a high dividend yield vs. their own history as well as relative to their peers.

Small cap companies source more of their revenue from the UK.

JPMGraph-4

Investment Implications

  • The UK economy is among the fastest-growing economies in the developed world. This faster growth is beginning to have an impact on wages for UK-based workers, who are experiencing the longest period of sustained real wage growth since the financial crisis.
  • Stronger wage growth and a healthier UK economy should be good for some UK equities, particularly small cap companies, which are more sensitive to changes in domestic growth.

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