With the MSCI World Index rising 44.1% from the low point of 12 March this year to 16 October, the U...
With the MSCI World Index rising 44.1% from the low point of 12 March this year to 16 October, the UK FTSE All Share has lagged with returns of 38.2%, all in sterling terms (source: Datastream, 17/10/2003). Why such timidity? Is this caution by predominantly UK investors based on a dispassionate assessment of the UK"s relative merits, or does it reflect an unjustified risk aversion that may correct itself in the near future? The answer may lie on two levels. The first concerns investors" perception of the UK"s relative economic health, seen from both home and abroad. The second concerns the UK market"s ability to attract capital, once again from both its domestic sources and external sources.
If we start with the economy, then there is the growing sense that UK GDP growth on an annual basis seems set to end 2003 well ahead of the eurozone, and indeed the European Union, average. Despite the questions raised by the recent upward revision of quarter-on-quarter GDP growth for the UK by the Office of National Statistics (ONS), from 0.3% to 0.6% for the second quarter of 2003, many commentators agree that economic recovery is gathering momentum. The shift in perception has been quite marked, given that the Department of the Treasury"s forecast of 2.25% to 2.5% GDP growth for 2003 seemed wholly unattainable six months ago and within the bounds of probability today. Interestingly, this shift in perception has come at the expense of government bond performance, as consensus opinion has begun to look at the possibility of rising inflation. With signs of improved activity in the UK manufacturing sector, strong service sector activity, as well as low levels of unemployment (3.1% according to UK data, around 5% according to the International Labour Organisation metrics) it remains to be seen how long it could take for inflationary pressure to build up, be it in the form of higher wages or higher prices for goods and services.
Perhaps this looks appealing to countries like Germany and France where demand has fallen to such an extent that the fight to beat deflation is still high on the agenda. Deflation is good for government bonds and awful for equities, relatively speaking (look at Japan from 1990 to early 2003). So why have eurozone equities outperformed UK equities since the lows this year? It could be argued that investors are looking sufficiently ahead and assume the core eurozone countries will achieve their objective of increasing economic activity through, among other developments, a recovery in corporate earnings. Continental Europe has historically lagged the US and UK in terms of the economic cycle, both on the way up, as well as on the way down. It could also be argued that eurozone equities fell so much more in 2002 and the first three months of 2003 than the US and the UK, that a stronger recovery from the lows is understandable given the more optimistic outlook by investors.
What of the UK"s ability to attract foreign capital? This is an important consideration as historical analysis of currency movements show that foreign capital flows are one of the key determinants of a currency"s exchange rate with other currencies. Strong sterling versus the other major currencies in the late 1990s helped to keep inflation down. A weaker sterling would have the opposite effect. It also has implications for other UK assets such as equities and government bonds. Here, the news is more mixed on a relative basis to equities and bonds in other non-UK regions. On the one hand most commentators agree the UK economy is growing well, although inflation may pick up in the future, which would necessarily imply a rise in interest rates to control it. On the other hand, public spending has risen considerably in the UK over the last 18 months and it is difficult to see how this could continue without some sort of fiscal hike, either at the personal or corporate taxation level or both. This rise in public spending may not appeal to foreign investors, particularly if UK corporate profits are reduced by a greater tax burden.
It is only fair to recognise that macroeconomic considerations can be difficult to interpret in a manner that benefits stock picking on a consistent basis. Given the vast majority of the UK"s companies by market capitalisation have operations and earnings outside the UK, only a global-orientated analysis can hope to gain some sort of accurate picture of these companies" prospects. Even with the global exposure provided by UK multinationals, this should not preclude the benefits of having a globally diversified portfolio, across sectors, countries and asset classes.
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