A shrinking pool of talent

The UK stock market has a problem: a shrinking in the number of listed companies. Research has shown that over the last decade, the London Stock Exchange coupled with the junior market, AIM, has seen a 25% decrease in the number of listed firms.

The pace of companies leaving the market due to takeovers, principally driven by opportunistic private equity buyers, has accelerated, but the hopper is not being refilled by new flotations. Even worse, more large UK companies are undertaking new listings in the US rather than the UK, while some are moving their listing from the UK to the US. This is not surprising, with UK equities trading at a significant discount to US peers. More UK companies are also returning cash to shareholders by buying their shares back, given the attractive valuations, but this shrinks their market value.

Some of the UK’s discount reflects self-inflicted problems such as Brexit and political instability, while the US has seen a stellar performance from the ‘Magnificent Seven’* technology mega-stocks and surge in demand for AI investments. Worryingly, the market capitalisation of the entire UK stock market is now broadly the same as Apple. The current ‘bubble’ in demand for AI has seen the UK stock market slip to under 5% of the ‘World Index’ of companies. This compares with the Magnificent Seven’s combined value of c.20% of the index. Food for thought!

The UK equity market matters. Equity is permanent capital that does not require refinancing and provides the means for listed companies to invest in growth opportunities in plant, people, and R&D, as well as scope to fund acquisitions. UK listed companies lead the way in sustainability and disclosure and are subject to a far higher level of analysis and scrutiny. Listed companies generally pay a full tax contribution, whereas companies taken private tend to be structured to avoid or lower tax. A strong equity market helps to stimulate economic growth. It provides both a growing store of savings, as well as income in the form of dividends.

For many years, there has been an overriding sentiment that markets operate successfully with limited input from the government. The focus has therefore been on regulation and control rather than growth. Encouragingly, both the government and opposition are wanting to engage to understand the issues, but concerted action is required. A few potential changes could drive a meaningful improvement, but the easiest must be by increasing demand for UK shares either by encouraging pension funds as well as retail investors. Perhaps launching a British shares ISA – something that was overlooked in the Autumn Statement – might be one way?

Either way, the current anomalously low UK valuations present investors and companies alike, with a great opportunity to acquire world class globally diversified UK companies at bargain levels.

*Amazon; Apple; Alphabet (Google); Nvidia; Meta Platforms (Facebook); Microsoft and Tesla

What have we been watching?

An important week for some central banks, given market optimism about the timing of interest rate cuts. The Federal Reserve (Fed) pushed back against market expectations of an interest rate cut as soon as March. Meanwhile, the Bank of England warned it wants a ‘lasting’ return to the inflation target. US equities touched another record high with positive results from some of the ‘magnificent seven’ including Meta (Facebook) which jumped on news of dividend and share buy-back plans countering unexpectedly strong US jobs data which would appear to support the Fed’s more cautious stance.

The conflict in the Middle East shows no sign of de-escalation. The US carried out a series of strikes on Iranian-backed militia groups in Syria and Iraq and further attacks on the Houthis in Yemen. Meanwhile, Tesla was once again forced to halt production at its plant in Germany due to supply chain disruption caused by Houthi attacks in the Red Sea. The volume of commercial shipping passing through the Suez Canal is estimated to have fallen by over 40%, while the cost of shipping a container from Asia to Europe has risen from $1500 in early December to $5,300. This increase is likely to be reflected in producer price inflation at some stage and will inevitably feed through into consumer price inflation. Could this delay central bank interest rate cuts? Possibly more so in Europe than the USA.

There was some good news for Ukraine, as all 27 EU leaders agreed an additional €50bn financial aid package. Hungary had previously blocked the deal.

The US presidential election is not until November, but it is already another reminder of a potential Trump presidency. Donald Trump has said he would impose more tariffs on Chinese goods, some in excess of 60% if he wins. Meanwhile, Fed Chair Jerome Powell has warned the US is on an unsustainable path regarding its national debt, which stands at more than $34 trillion. ‘It is probably time, or past time, to get back to an adult conversation with elected officials about getting the federal government back on a sustainable fiscal path.’

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In the UK, shop prices increased at their slowest rate in more than 18 months. Prices increased by 2.9% in January, down from 4% in December. The Bank of England (BoE) held interest rates at 5.25% as expected, with market focus on forward guidance. The BoE said it expects CPI to ebb temporarily below the 2% target in the second quarter of this year, before increasing in the third and fourth quarters. It wants a ‘lasting’ return to target and seems most concerned by services inflation which although it is expected to ease as the year progresses, looks likely to be at a slower pace than other components of the CPI basket. The BoE will also have to factor in any further fiscal loosening (tax cuts) that Chancellor Jeremy Hunt seems keen to deliver at the March Budget. Analysts are still suggesting an interest rate cut is likely by June, if not May.    

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The Eurozone stagnated in the final quarter of 2023 with GDP unchanged, following a slight decline in the previous three months. Germany was the weakest of Europe’s large economies, with output falling in the final quarter, reflecting the manufacturing sector’s exposure to China. However, Christine Lagarde, President of the European Central Bank (ECB), said ‘we have the conditions for recovery that are coming into place. I am not suggesting that it is going to pick up rapidly, but it is coming into place from what we can see.’ Eurozone inflation dropped to 2.8% in January from 2.9% in December although services inflation is proving ‘sticky’ at 4% which may concern the ECB.

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In the US, the Fed’s likely interest rate actions appear to all be about ‘confidence’ in inflation returning to 2%. The Fed is clearly preparing for lower rates soon, with the cut being a question of when, not if. Fed Chair Jerome Powell tried to guide expectations on such timing, pushing back on a March interest rate cut, without ruling it out in its entirety. Financial markets have slightly reduced their bets on a March rate cut, with many analysts shifting to May/June but have ramped up expectations for rate reductions by the end of the year. The Fed also confirmed that bond holding reduction -QT- will continue as previously guided at $95bn per month. Meanwhile, US manufacturing activity picked up in January with a PMI reading of 50.7, however, factory costs appear to be rising due to the recent disruption from adverse weather and global shipping and these higher costs are feeding through to increased prices charged for goods by factories.

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Brent oil dropped to $77. Saudi Arabia’s Aramco said will cancel a planned increase in oil production capacity from 12 million barrels a day to 13 million by 2027 after receiving an order from the country’s Energy Ministry. Aramco is currently producing 9 million barrels a day. A sign Saudi Arabia is less optimistic about global oil demand?

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Finally, UK food groups are warning of supply chain disruption. This is due to the introduction of post-Brexit complex paperwork to certify all EU products of plant and animal origin from the 31^st January. The government has delayed the introduction of these checks five times since 2021. Besides impacting availability, the new rules could drive up the price of some foods. A European trade facilitation business warned, ‘Your prices are going to go up.’ If true, that would not be helpful for inflation or those households struggling with the cost-of-living crisis.

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.