Tatton teaser: Is the UK economy as gloomy as it appears ?

Posted 26 October 2022

There appears to an endless supply of gloom when it comes to the UK economy at present. The cost of living crisis, higher prices in the shops, war in Europe, the growing effects of climate change, the debacle of three Prime Ministers in three months. But are things as cloudy as they might appear? From an investment point of view, and in Pound Sterling-terms, large-cap UK stocks actually outpaced peers in Europe, the US and Japan on a year-to-date basis. Conceptually, the UK might be thought of as more of a ‘value’ market with typically higher weights to sectors like energy, mining and financials, so understanding the UK’s relative performance is fairly straightforward against a backdrop of rising interest rates and higher commodity prices.
But a look at how global investors value UK stocks suggests a slightly different picture. The chart shows the last sixteen years of valuations and dividend yields in both UK and global stocks excluding the UK. The green line is a simple ratio between the 12-month forward Price-to-Earnings levels of Global ex UK divided by UK and the bars are UK dividend yields minus global ex UK yields.

Based on PE’s alone, UK stocks are trading at a substantial discount of 43% versus global and also a 28% discount to the median sixteen-year UK PE. However, global trade in-line with its sixteen year median of 16x and the UK at just 9.1x forward earnings. Several factors, including those listed, earlier may lie behind this valuation discrepancy. There’s a separate question of whether UK equities deserve this discount but it would appear investors believe global stocks are likely to offer more growth.

But – and there can often be a ‘but’ – UK stocks offer investors just over double the dividend yield vs. global ex UK. That dividend gap has been steadily increasing since 2010, despite the fact UK stocks traded at an ever wider discount. Indeed, understanding that returns can be more than just price movements but also viewed on a total return [price change plus any dividends received] could be just as important. It’s clear there are some very large hurdles facing the UK economy in the shorter-term, but that does not always mean things are as terminal as some might fear, nor that we cannot mitigate or potentially overcome these challenges in the long-run. UK stocks do trade at a discount, but it seems they are not entirely without their [dividend] attractions.

Thank you Sam Leary for this note.

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