A year ago, things were relatively rosy in the UK. Inflation was at 5.5 per cent, interest rates were at 0.25 per cent and although energy prices were rising, they had yet to surge after the Russian invasion of Ukraine in February.
Today, via the Liz Truss government that spooked the markets and sent the pound plunging, times are a lot tougher.
UK inflation is running at 10.5 per cent, the Bank of England has set interest rates at 3.5 per cent and household energy bills have, in many cases, at least doubled.
The country had three prime ministers and four chancellors of the exchequer over the course of last year — a year of two halves for the housing market. It went from 12.5 per cent annual growth in July to 2 per cent in December.
Strikes are now widespread in several sectors of the UK economy. From rail workers to nurses, from driving test examiners to Border Force officials, there was not a day in December that was free from protest action.
While the unemployment rate, for the moment, seems steady at 3.7 per cent, real wages fell by 3.9 per cent between September and November compared with the year before — the largest decrease in more than a decade.
So, given all this, is the UK an attractive proposition for investment?
The short answer is yes; the long answer is yes, but savvy investors will need to seek out the best candidates in what is at first glance a bleak environment.
Putting stock in investing
The stock market is a good example. Since the Truss government's mini-budget in late September, which sent shares and the pound tumbling, the FTSE 100 index of blue chip shares has gained 7 per cent and by this week was flirting with all-time highs. The pound hit a low of $1.0327 in late September, but has climbed 14 per cent since.
The FTSE 100 anomaly can be explained, though. Three quarters of the earnings of constituent companies are made outside the UK and so benefit from a weaker pound.
But what also plays a part is what might be called the tortoise and hare factor. The FTSE 100 has more tortoise stocks than hare shares — more defensive than growth stocks.
Its main companies are involved in what some may see as mundane and boring sectors, such as banking, pharmaceuticals, mining and consumer products. But these slow, tortoise defensive stocks tend to do better in recessions.
London's FTSE 100 has relatively fewer of the high-tech, Silicon Valley growth stocks that can hare upwards but quickly lose momentum.
“The proliferation of mining and oil stocks saw a strong benefit from soaring energy prices last year, while there is also a large contingent of financial stocks which are generally boosted by rising interest rates as the 'positive jaws' [the difference between the rates at which banks lend and borrow] widen,” Richard Hunter, head of markets at Interactive Investor, told The National.
“At the same time, there are a number of defensive stocks with pricing power, which mitigates the effects of inflation, as these companies have the ability to pass on price increases without sacrificing market share, such as the likes of Diageo, Unilever and Reckitt Benckiser.”
Although the FTSE 100 is hovering close to record highs, analysts say this shouldn't deter potential investors who might think they've missed the opportunity and that the index is now overvalued. Far from it, Jason Hollands, managing director at Bestinvest, told The National.
“What matters is the relationship between share prices and expected earnings and on this basis, UK equities are a true bargain,” he said. “Currently, FTSE 100 shares are on aggregate trading at 10.4 times their forecast earnings for the next 12 months.
“That is an enormous 29 per cent discount to valuations on broader global equities and it is also well below the longer-term average level of circa 12.5 times they have traded at. It is a mug’s game to try and second guess short-term market movements, but these levels do suggest significant upside potential over the coming years.”
Dividend payouts and bond yields
Another reason that the FTSE 100 looks attractive this year is dividends. The index is one of the world's largest generators of dividend payments to investors.
Simply put, banks tend to make more profit when borrowing costs go up and resource companies do well during commodity booms. So, because higher company profits usually equate to increasing dividends, the FTSE 100, which is littered with such companies, is expected to look attractive to investors over the course of the year.
“The average yield of the index is currently 3.5 per cent, nearer to its longer-term level after the ravages of the pandemic dissipate,” Richard Hunter at Interactive Investor told The National.
As such, because the fortunes of the FTSE 100 are decoupled from the storms of the UK economy, London's blue-chip shares have an allure than belies the general doom and gloom.
“Despite the bleak outlook economically, UK markets are undervalued relative to their peers,” Michael Hewson, chief markets analyst at CMC Markets, told The National. “With interest rates at more normal levels the focus is set to be more on value as opposed to growth, which means income stocks are likely to be more prized.”
Investors have also been curious about the UK's bond market in the past few months. Government bonds or gilts looked attractive as the Bank of England started its steady increase march to higher interest rates last year. But Ben Yearsley, investment director at Shore Financial Planning, told The National that this year, it's all about corporate bonds.
“I actually bought gilts in September for the first time since 2009, as the yield on offer was simply too good to pass up,” he said. “That opportunity has gone and I see interest rates peaking soon — February could be the last hike. So, gilts look better than this time last year with the 10 year paying over 3 per cent, but you can get over 6 per cent from investment grade corporate bonds. Now, that’s a much better opportunity.”
UK house prices have been falling for a few months now and that trend is expected to continue. According to the latest Halifax Price Index, the price of the average house in the UK in December was £281,272, a fall on the previous month of 1.5 per cent.
Last year was a game of two halves for the UK housing market, which posted strong growth until about July. But after the economic picture deteriorated, inflation and energy costs ramped up, interest rates began to increase and, generally, the cost-of-living crisis started to bite and house prices began their steady decline, dragging down overall house price growth for the year.
Kim Kinnaird, director at Halifax Mortgages, said: “As we enter 2023, the housing market will continue to be impacted by the wider economic environment and, as buyers and sellers remain cautious, we expect there will be a reduction in both supply and demand overall, with house prices forecast to fall about 8 per cent over the course of the year.
“It’s important to recognise that a drop of 8 per cent would mean the cost of the average property returning to April 2021 prices, which still remains significantly above pre-pandemic levels.”
A survey this week from the Royal Institution of Chartered Surveyors (Rics) showed last month's house prices had registered the most widespread fall in 13 years.
The Rics balance, which measures the difference between the percentage of surveyors seeing rises and falls in house prices, slumped to minus 42 in December from minus 26 the previous month.
While prices fell across all regions of the UK, the biggest falls were in East Anglia and the South-East.
Simon Rubinsohn, chief economist at Rics, said the survey “highlights challenges in the housing market as new buyers grapple with more costly finance terms and uncertainty over the outlook of the economy”.
The UK's commercial property market also had a rough 2022 as the economic picture deteriorated.
Returns on investments fell 10.4 per cent last year, according to MSCI's monthly UK property index published this week. It was a very different situation in 2021, when the returns gained 20 per cent.
Mirroring the falling house prices, much of the losses came in the second half of the year.
Several open-ended property funds have placed restrictions on withdrawals to prevent a mass exodus of investors.
The rental sector had a turbulent time last year, as the supply of residential properties for let tightened significantly while demand stayed strong.
The Rics survey showed a fall in the number of new landlords, which suggest fewer properties coming on to the rental market.
According to the property analytics company, TwentyCi, in September 2019 there were 120,610 new rental listings at an average price of £1,290.
Three years later there were a third fewer new listings and prices had risen by 20 per cent.
Many, including Rics, forecast that rental prices will keep rising this year.
However, some analysts feel the supply squeeze in the rental market may be reduced as sales in the residential sector slow.
“On the one hand rents are rising sharply as supply struggles to keep pace with robust demand in the lettings market, which means the rental option is an attractive option for many owners,” Tom Bill, head of UK residential research at Knight Frank, told The National. “As the sales market slows, we may see more owners think the same way, and the increase in supply would put downwards pressure on rents.
“That’s why we think the strongest rental value increases are now behind us. For now, a growing number of owners are exploring both options and the right choice will vary greatly depending on individual circumstances.”
Overall, opinion on the investment potential of the UK property market varies to a greater degree than it has for some time, principally because of the economic headwinds battering it.
Ben Yearsley from Shore Financial Planning told The National the property market won't “be disastrous, but I can't get too excited about it”.
“Physical property held up well last year, whereas listed property trusts and companies took a beating. I’m on the fence on property,” he added.
For Jason Hollands at Bestinvest, the UK property market is looking ripe for the overseas buyer, but timing in 2023 will be the key.
“For overseas buyers with cash available, physical property could be an opportunity at some point given widely expected price declines as higher borrowing costs hit the market and store closures and insolvencies surface in the commercial property sector, but it is too early to make that move,” he said.
Boons for savvy investors
Although the uncertainty over the performance of the UK economy and the negativity that seems to have been part of much British business news over the past six months is still lingering, there is increasing light in the darkness.
John Allen, the chairman of the UK supermarket chain Tesco and the homebuilder Barratt Homes, is optimistic about investing in Britain in the long term, but acknowledges there may be some "short-term issues".
"The UK’s a great place to invest in for many companies. What we’ve got to do is demonstrate that we know our way forward, restore confidence and we could actually see a reasonable return of inward investment,” he told the BBC on Friday.
“Given how long UK assets have lingered under a risk premium, further gains could be ahead once storm clouds retreat from the global economy,” said Susannah Streeter at Hargreaves Lansdown.
Jason Hollands at Bestinvest told The National that “UK investments, priced in pounds, look especially cheap to international buyers and I suspect this will soon start to drive an increase in acquisitions of UK companies, providing an additional opportunity for shareholders”.
All investment carries risk and even the brightest pockets in Britain are no exception to that rule. If nothing else, 2023 will be an exercise for investors in how to hunt for value.