The UK is heading into 2022 with one of the most positive market outlooks of any major developed economy, but investors are slow to realise it, according to JO Hambro managers James Lowen and Clive Beagles.
Lowen and Beagles said they were “utterly bemused by valuations in the UK stock market”, at the moment, claiming prices were well below the levels they should be given the strength of the UK’s economic outlook.
“In an absolute sense, valuations across our portfolio continue to look extremely undemanding,” they said.
The pair run JOHCM’s £2bn UK Equity Income fund, and said that overall balance sheets were in “extremely good shape” and that they expected the fund’s dividend to return to pre-pandemic level of 5% during 2022.
“Rarely, if ever, have the relative attractions of the UK and our fund been brighter than this, yet very few investors seem to be interested,” they said.
They added that the investment picture for the UK was much stronger than the US going into next year because a value-dominant market like the UK’s would be more ideal than growth areas for the rising interest rate environment being forecast.
The US has been the powerhouse in global markets for several years, driving global returns with its growth-quality bias and high concentration of technology names, while the UK market has generally lagged as it comprised of slower growing, more economically sensitive cyclical stocks.
Performance of US vs UK indices over 10yrs
Source: FE Analytics
Comparing the UK and US’s economic recovery this year, the managers said that despite Covid headwinds both have been “extremely strong” but argued that rarely have the “attractions of the UK been brighter than this”.
Part of this has been the UK’s positive wage growth forecasts and employment data, factors the US has lagged on.
The latest Office for National Statistics (ONS) data found there were 1.2 million job vacancies October and 1.4 million who are unemployed post furlough, “suggesting an economy effectively at full employment”, the managers said. At the same time wage growth had risen to 4.3% in the third quarter.
The US has had a tougher time on this front with the latest employment data falling short of analysts’ expectations, although the unemployment rate did fall in November by 4.2%.
But this data does not reflect the emergence of the Omicron variant at the end of November, which could affect the economic recovery.
Lowen and Beagles said employment and wage growth were “the key drivers of economic growth and, as such, we continue to expect further upward revisions to the official UK GDP data, which has been a regular occurrence in recent years,” the managers said.
This is an important backdrop going into 2022 as stronger growth can be a trigger for policy makers to start withdrawing stimulus and means investors have to look for what the managers called, “the economic maths”.
Both regions are expected to experience inflationary pressures, however the UK should benefit more as the market is more heavily weighted towards oil and mining stocks, which should do well if the prices of energy and metals rise.
Other industries that require these commodities, such as housebuilders, travel and industrials, can take heart from the strong wage and economic growth, which should help offset this, as well as the additional £200bn of consumer savings stockpiled in 2020, the managers said, even if households end up with less free cash flow.
“Combined with an economy at full employment and a proactive government investment programme, this could drive real UK GDP in 2022 well above 6% and nominal GDP (which is what really matters for corporate earnings) towards 10%,” Lowen and Beagles said.
The managers said that despite this bright outlook for the UK economy its valuations and investors’ enthusiasm did not match it.
They said: “Despite very clear messages from private equity buyers that the UK is comfortably the most attractively valued developed market in the world, the rest of the investment community just doesn’t seem to be listening.”