Ben Russon, co-head of UK equities (large cap) at Martin Currie outlines the top five reasons for investors to be positive for the year ahead.

If 2023 is anything like 2022 then the UK may be in for a bumpy ride, Ben Russon at Martin Currie said on Friday.

He highlighted how inflation had surged, interest rates soared, currencies swung, and the UK government clashed. 

However, while macroeconomic headwinds remain, Russon believes that there is reason for optimism for UK equity investors who are taking an active approach to managing the risks and identifying the opportunities. 

Here are his top five reasons for investors to be positive in the year ahead.
 
Stabilising global inflation will calm markets
Russon believes that an easing of global inflationary pressures is beginning to unfold. Data released in November showed that US consumer prices had risen by 7.7 per cent over the past 12 months, falling short of the 8 per cent estimates. In December, China announced a reversal of key zero-Covid policies after weeks of civil unrest. Global commodity prices have also moderated since their extreme volatility earlier in the year. 

“As inflation looks like it is peaking in the UK, the news of a cooling backdrop in the US has helped drive a re-rating of equities and a pullback in government bond yields domestically. Inflation in the UK is expected to continue to fall back from highs over the next few months although the impact from changes in consumer energy support policy will likely be a key determinant as to how this plays out,” he said.
 
Central bankers can start to take a breath
Assuming an easing in headline inflation figures, he expects the central bank to be nearing a peak in its monetary tightening programme. 

The Bank of England recently made steps to reduce its balance sheet, embarking on a programme of quantitative tightening in Q4 2022, he said. Higher interest rates mean higher financing costs for corporations and consumers. Combined with the tighter flow of liquidity, this may present some short-term challenges for UK equities whilst the positive effect of moderating inflation takes its time to embed into supply/demand habits, he continued. “Key economic concerns are the length and depth of this inevitable slowdown – investors remain closely focused on the central bank response as the risk of a policy mistake is increased,” he added.

He believes that the perception of a safe pair of economic hands in the Sunak/Hunt duo has improved sentiment towards the UK into 2023. “With gilt yields stabilised, and an economic catastrophe seemingly circumnavigated, relatively benign markets will be well received by the Bank of England as they execute monetary policy over the coming months,” he said.  
 
The extreme impact of inflation is not universal  
He believes that the UK remains in a position of strength from the perspective of excess household savings – savings accumulated throughout the Covid-19 pandemic are now earning an attractive rate of interest income. 

“Furthermore, the UK mortgage market has evolved since 2005 – the last meaningful period of central bank tightening – when 70 per cent of mortgages were financed on variable terms. Today, only 14 per cent of the UK mortgage market is financed with variable rates. The extent of fixed rate mortgage financing and indeed outright home ownership within the UK should continue to partially offset the cost-of-living burden instilled by soaring consumer energy bills,” he continued. But he does expect a degree of consumer caution to remain until broader costs begin to moderate.

The labour market remains strong relative to history
“The labour market has continued to demonstrate resilience throughout this period of volatility,” he said. “Although latest data indicates that unemployment rose to 3.7 per cent in Q3 2022 and that vacancies dropped for the fifth consecutive quarter, one must be reminded that the labour market remains buoyant relative to historic levels,” he added. Signals such as a falling labour inactivity rate are indicative of employment re-engagement particularly amid the over 50s, as soaring costs prompt ‘early retirees’ back into employment. He therefore does not expect a surge in the unemployment rate, which should provide some protection against the risk of a prolonged, severe recession.
 
Equity value remains, particularly compared with global markets
“Despite the relative strength of the UK equity market throughout a period of heightened volatility, investors remain mindful of the value that remains,” Russon continued. The UK market, which is trading on a forward P/E ratio of around 10x – 20 per cent beneath its 15-year median – offers a dividend yield of 4 per cent. Contrasting with the US, trading on a forward P/E ratio of around 18x – 12 per cent above its 15-year median – and a dividend yield of 1.7 per cent, UK equities look cheap, he said.

An economic slowdown is widely anticipated across global markets and, as such, should investors continue to address the notion? Is this bad news already priced into UK assets? 

“The UK market remains forward-looking and, in our mind, is pricing in an excess of pessimism given where valuations are today,” he said. “The attractiveness of the region is therefore enhanced to investors as evidenced by ongoing M&A activity, as indeed are the prospects for continued resilience through 2023 and beyond," he concluded.