By Jason Hollands
Many people perceive the stock market to be a barometer for the health of the economy. So, with the near-term economic outlook for the UK rather gloomy as the cost-of-living crisis bites and the Bank of England continues to hike borrowing costs, it might seem somewhat surprising the UK equity market is one of the best relative performers globally this year.
Admittedly this is against the backdrop of a turbulent period for equity markets, so “best performing” does not mean stellar gains. But unlike the US market which has posted sharp losses during the first five months of 2022, at the time of writing the UK market is in positive territory.
Surely if the economic headwinds for the UK are as grim as many economists think, is it not time to give UK shares a wide berth?
In truth, regional stock markets and economies are not one and the same thing. This is especially true when it comes to the UK equity market which is more international in nature than any other market.
While around 60 per cent of the revenues from companies in S&P 500 Index were “born in the USA”, the underlying earnings exposure of UK listed companies are overwhelmingly global. It is estimated that just over a quarter of the revenues of UK-listed companies are made in the UK and three quarters come from overseas. In fact, the UK stock market’s domestic revenue exposure is pretty similar to what its constituent companies earn in the USA.
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Of course this is skewed by the profile of the UK’s largest companies, including global players in sectors like energy, commodities, financial services and consumer staples.
But even amongst the medium-sized companies lurking just outside of the FTSE 100 super league, just over half of their revenues are made outside of the UK.
Alongside businesses that operate globally, the main London Stock Exchange and its sibling AIM exchange for small and medium-sized growth companies is home to shares from over 350 overseas businesses. When it comes to the “UK” stock market, there is a ring of truth in the idea of “Global Britain”.
But a relatively modest link between the UK equity market and the UK domestic economy doesn’t on its own explain why it has held up so much better than global equities overall this year, and the US market in particular. The answer to that requires a look beneath the bonnet at the very different make-up of sectors reflected on the UK market compared to the US.
The global equity rout of recent months has not been uniform in nature. Rampant inflation and the prospect of an aggressive rise in borrowing costs has been particularly brutal to “growth” stocks like technology and communication services companies, as well as consumer discretionary companies that make things people can frankly live without buying in a time of belt tightening, like a new Tesla car.
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The three aforementioned hard-hit sectors represent a whopping 47% of America’s S&P 500, but only 14% of the UK equity market. But it isn’t just the fact that the UK equity market has low exposure to the hardest-hit industries; it also has greater exposure to those pockets of the market that have done rather well.
The UK market’s exposure to oil and gas companies and also basic materials is three times that of the US.
Consumer staples businesses that make everyday stuff people will keep on buying whether the economy is on the up or down represents more than 19% of the UK market compared to less than 7% in the US.
Of the four best-performing industry sectors globally in the year to date (energy, utilities, consumer staples and materials), the UK market has a 46% weighting while the US exposure to these areas is a mere 17%.
So though the UK economy faces a challenging period ahead, don’t ignore the UK equity market. It has qualities that should stand it in relatively good stead. The UK equity market and domestic economy are not, thankfully, one and the same thing.
Jason Hollands is a managing director of Tilney Smith & Williamson, which will shortly be rebranded Evelyn Partners
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