The underperformance of the UK stock market compared with the historic bull run in the US cannot be easily attributed to issues such as Brexit and the US’ stimulating tax cuts, economists at Pantheon Macroeconomics have argued.
Last week, the S&P 500 entered the longest bull market in its history after going 3,453 days without being hit by a 20 per cent correction. Between starting to recover from the financial crisis on 9 March 2009 and 22 August 2018, the index made a 323 per cent return (without income reinvested and in US dollars).
Over the same period, however, investors in the UK stock market have achieved significantly lower returns with the FTSE 100 rising just 113.82 per cent. Of course, UK equities tend to pay higher dividends than the US (currently yielding 3.79 per cent versus 1.94 per cent) but even when income is reinvested, the UK has lagged by a wide margin – as shown below.
Price and total return performance of indices between 9 Mar 2009 and 22 Aug 2018
Source: FE Analytics
Samuel Tombs, chief UK economist at Pantheon Macroeconomics, pointed out: “Over the last decade, then, returns for investors in UK equities have been less than half those for holders of US equities.”
In the decade since the global financial crisis, the US stock market has been supported by the ultra-low interest rates and the massive quantitative easing (QE) programme launched by the Federal Reserve. Between 2015 and 2018, the Fed grew its balance sheet by $3.6bn – equivalent to almost 20 per cent of GDP.
But the UK’s underperformance cannot be blamed on a lack of equally ambitious stimulus, Tombs added. The Bank of England’s own QE programme amounted to £445bn – which is even bigger than the Fed’s, proportionately, at 22 per cent of GDP; furthermore, short rates are more than 100 basis points lower in the UK than in the US at the moment.
The move at the start of 2018 by US president Donald Trump to lower the Federal Corporate Tax Rate from 35 per cent to 21 per cent is a short-term factor bolstering the rally in the US stock market.
However, Pantheon Macroeconomics pointed out that the tax regime in the UK has been “just as kind” for some time: the UK’s main rate of corporate tax stood at 30 per cent a decade ago but has been cut progressively to 19 per cent today. What’s more, it will lowered to 17 per cent in April 2020, which should be supporting equity prices today.
The fact that the UK voted to leave the EU in the summer of 2016 hasn’t helped the UK stock market in the two years since but Tombs thinks it would be wrong to cite this factor as the main cause of the country’s underperformance – especially as the UK lagged the US before this event.
Performance of UK equities relative to US equities
Source: Pantheon Macroeconomics
“UK equities underperformed their US equivalents in the first half of this decade too. Indeed, UK equities have fared worse than US equities on a fairly consistent basis since the late 1980s,” the economist argued.
“This underperformance reflects deep-rooted issues, such as poor productivity growth, insufficient corporate spending on R&D [research & development] and scalability; even the single market isn't frictionless.”
All of the above issues are the main reasons the UK has lagged over the long run and are clearest when the technology sector – which has led the rally in the US and is a favourite area for fund managers – is considered.
Tombs said tech is “microscopic” in the UK, owing to issues such as lower R&D and lacklustre productivity growth. Technology companies account for just 0.8 per cent of the MSCI United Kingdom index; the sector makes up 26 per cent of the MSCI USA index.
In contrast, the sector in which the UK is dominant have struggled. Financial services are more than 20 per cent of the MSCI United Kingdom index but only 14 per cent of its US counterpart; energy stocks make up 17 per cent of the UK market but just 6 per cent of the US.
The past 10 years have been challenging for energy businesses and other natural resources stocks because of the end of the commodity super-cycle and depressed commodity prices.
When it comes to financial services, the UK suffered when banks’ profitability was hit by redress for products that were mis-sold before the financial crisis. In addition, UK banks were compelled more than their US peers to use cash flow to improve capital ratios.
Tombs said these are transitory issues that should no longer hold back equity prices as severely as they have. But this doesn’t mean the UK is set to outperform the UK once these have passed, given the strength of headwinds such as poor productivity growth.
“The structural nature of the underperformance of the FTSE 100 suggests we don't expect the index to catch-up with the S&P 500 any time soon, even if a disastrous no-deal Brexit is avoided,” the economist concluded.