2 months ago • 5 mins
The UK’s big stock index has been unloved and overlooked by investors all year. But it’s kept a stiff upper lip, at least, and now things just might be looking up. Inflation finally seems to be falling toward the Bank of England’s (BoE’s) target level, and that means there’s the possibility of interest rate cuts – and a change in fortunes for the neglected FTSE 100 – in the year ahead. So let’s take a look at where you might Britain’s best-looking opportunities…
London’s big-cap benchmark index posted a modest gain in the year, while Wall Street’s S&P 500 rose by a fifth on hopes of a soft landing for the US economy and the prospect of at least three Federal Reserve rate cuts in 2024.
All year, Britain’s index has traded at a big discount to its global peers. The FTSE 100 index currently trades on a 12-month forward price-to-earnings multiple of about 10.5 times, some 15% to 20% below its long-run average and a third lower than its global peers.
If 2023 turns out to be the trough for earnings, you could expect good things from the FTSE 100 index in 2024 – particularly if the US avoids a major recession and inflation pressures continue to dwindle.
Swiss bank UBS is forecasting, for example, that blue-chip earnings will grow by around 5% next year, having declined in 2023 mostly because of the impact of a year-over-year fall in commodity prices.
It expects the FTSE 100 to reach 8,160 by December 2024 and – coupled with an attractive 4% dividend yield – that suggests investors could see double-digit returns on equities next year.
As well as the benefit of earnings growth, it sees the potential for a slight re-rating as lower interest rates increase the present value of equity cash flow.
Despite that rosy outlook, the UK is still among the least preferred, mostly because emerging markets equities are forecast to see double-digit earnings growth next year.
However, the generally more upbeat view on UK equities is shared by interactive investor customers, with almost half of respondents to our recent survey seeing the FTSE 100 between 7,500 and 8,000 this time next year.
A quarter are betting on the index finishing 2024 above the 8,000 level, of which 8% think 8,500 or higher is possible. Only 6% think the index will end 2024 below 7,000.
Offsetting the blue-chip index’s lackluster headline performance during the past year has been its 4% dividend yield alongside the trend for major share buybacks.
Computershare’s quarterly Dividend Monitor expects 2023 to show payout growth of 5.4% when excluding special awards or currency movements. Shell and BP, for example, increased their December distributions by 32% and 21% compared with a year earlier, while Associated British Foods ABF lifted its dividend by 37% in the September financial year.
And it’s worth remembering the shelter provided by the FTSE 100’s heavier weighting of old economy stocks when macroeconomic conditions were tougher in 2022.
Those defensive characteristics may be needed again at the start of a year when major elections loom in the UK and US, geopolitical events remain a big worry and the full lag effect of interest rate rises is still to be felt.
For now, however, the recent third-quarter results season in the United States has suggested that many companies have had their earnings recession, have cut costs, and are now seeing their profit margins expand.
Bank of America said 2023 “defied almost everyone's expectations” with recessions that never came. It won’t have been easy, the bank admits, but it says it expects central banks to hit the soft landing in the next year – that ideal scenario where interest rates bring inflation back to earth without crashing the economy.
The question for investors is whether they have gone too far in pricing in the first interest rate cuts.
The Federal Reserve is seen cutting as early as the first quarter of 2024, followed by the European Central Bank and Bank of England in the second quarter.
On five out of the eight occasions since the 1980s that the US Federal Reserve has cut rates, the Bank of England has followed suit within three months.
Despite this, Capital Economics thinks investors are overestimating how quickly the Bank will cut rates. She points out that the UK’s labor supply is smaller and domestic inflationary pressures are greater than those in the US and the eurozone.
Mortgage rates are already falling, however, with a typical five-year fixed 75% loan-to-value deal now below 5% and lender Halifax hopeful of a narrow 2-4% fall in house prices in 2024.
The improvement in affordability could underpin the recent share price recovery of housebuilders Taylor Wimpey and Barratt Developments or ease some of the bad debt fears hanging over the valuation of lenders including Lloyds Banking Group.
Among other sectors, sentiment has turned more positive on the mining sector in recent weeks amid hopes for a demand recovery in the second half of 2024.
Deutsche Bank has “buy” recommendations for the likes of Glencore and Rio Tinto Registered Shares after forecasting broadly balanced markets for copper, aluminum, and iron ore in 2024 before supply deficits re-emerge in 2025 as the global demand cycle recovers.
Bank of America expects Vodafone to bottom out in 2024 results and for the year ahead to be boosted by a significant turnaround in energy costs.
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