In the UK, the first half of the year was difficult, and the outlook remains gloomy. Investors expected Prime Minister Keir Starmer, in office for twelve months, to revive the economy.
These hopes seemed logical, given that the Labour Party's return to power coincided with a decline in inflation and a Bank of England finally ready to launch a cycle of rate cuts. But twelve months later, this recovery scenario is being questioned, and there is cause for concern. We are not currently investing in the UK.
Little room for manoeuvres
The problems facing the British economy are nothing new. Heavily dependent on abundant and cheap credit for its growth, the UK has never truly recovered from the economic and financial crisis of 2008/2009. Since then, its per capita GDP and productivity have shown very disappointing growth rates, far from those of previous years.
To address this stagnation, London must make difficult choices but has been avoiding them for nearly two decades.
The result is a struggling infrastructure that can no longer keep up, a beleaguered national healthcare system, and a chronic inability to support investment and productivity, both of which are necessary to revive wealth creation. Exiting the European Union and the pandemic have constituted two additional shocks, further hampering the country's ability to attract investment and public finances.
Country needs a recovery plan
Keir Starmer, therefore, has his work cut out for him. He had promised not to increase the tax burden and to invest in the country's infrastructure, particularly in the NHS, the national healthcare system.
But fiscal realities are staring him in the face, and investors are nervous. Lacking a decent recovery plan, the country is currently paying dearly for its financing, with 10-year bonds exceeding 4.6% and maturities over 15 years exceeding 5%.
With the UK's public debt at 96% of GDP, the country's debt burden is substantial and limits the UK government's room for manoeuvre. The latter is closely scrutinized by investors, who are on the lookout for any new fiscal escalation and do not hesitate to rush for the exit at the slightest sign of trouble. This explains the turbulence in the British bond market in recent weeks.
Monetary policy has a limited impact
Without the necessary room for manoeuvre to influence budgetary and fiscal policy, investors expected the Bank of England to implement an expansionary monetary policy that would encourage a return to demand. The British central bank has taken action, agreeing to four rate cuts since the new government took office and reducing its key interest rate to 4.25%.
But unfortunately, this less stringent monetary policy has not lived up to all its promises.
On the one hand, consumers, who were expected to regain momentum thanks to cheaper credit, saw their disposable income decline in the first quarter. Yes, wages increased somewhat, but inflation, an increased tax burden, and the elimination of certain household subsidies pushed disposable income growth into the red.
On the other hand, the decline in key interest rates was not reflected in the most extended maturities. Over the past year, the UK key rate fell from 5.25% to 4.25%. But at the same time, the 10-year rate took the opposite path, falling from 4.1% to 4.6%, a sign that investors are struggling to trust the UK.
Stock Exchange lost attractiveness
An additional problem for the country is that the City of London has lost its appeal, and the London Stock Exchange is no longer generating revenue.
In the first six months of the year, the stock market, which once dominated other European stock markets, saw only five initial public offerings (IPOs), with a total volume of approximately £160 million (€185 million). To find such a low volume, you have to go back to 1995. Even at the height of the 2008/2009 financial crisis, London saw more activity.
Contrary to what was predicted when the country left the European Union, its decline has not benefited other European stock exchanges; instead, it has benefited the New York Stock Exchange, which boasts much greater liquidity.
This phenomenon also affects already listed companies, many of which (including the largest capitalizations in pharmaceuticals and energy) are considering a move to the United States, where they hope to achieve higher valuations than those they can achieve in London.
Almost no technology options
The London Stock Exchange is, therefore, struggling to attract new companies and retain some existing ones.
In the absence of new profiles, it is stagnating, dominated by traditional sectors such as finance (24% of the MSCI UK), consumer staples (16%), manufacturing (16%), healthcare (13%), energy (11%), and raw materials (6%).
A well-diversified stock exchange, therefore, but virtually without technologies, which have been a staple of the American markets in recent years. The information technology sector represents only 1.2% of the MSCI United Kingdom.
Fortunately, the industry, particularly the defence sector that dominates it, is benefiting from the West's renewed enthusiasm for armaments. Thanks to giants such as BAE Systems (buy) and Rolls-Royce, the British stock market remains in the black, ending the first half with a gain of nearly 5% (in euros, price and dividends).
Advised opportunities
However, at this stage, it isn't easy to see other sources of growth. Of course, given this uninspiring outlook, investors are not rushing to buy British stocks, which are not particularly expensive.
With a price/earnings ratio of around 13x, this market is valued well below the global index (23x). It, therefore, remains the main asset of the London market and undoubtedly the one that will justify a return to this market in the future.
But for now, this argument seems insufficient to justify a purchase. Numerous challenges remain, and we therefore prefer to focus on a few individual stocks, which are better positioned to perform well than the British market as a whole.
Already mentioned as benefiting from the return of enthusiasm for armaments, BAE Systems is a worthwhile investment. The same goes for Diageo. Its extensive portfolio of must-have brands (Guinness, Johnny Walker, Smirnoff, and Baileys, among many others) provides it with a solid foundation. Add to this the ongoing cost-cutting plan, and you have the ingredients that should allow it to stand out.
See our recommended portfolio.
UK Debt Curve (In %)
With interest rates among the highest in industrialized countries, financing UK debt is relatively expensive, and debt service charges limit the Labour government's room for manoeuvre.