Outlook: Foreigners see a bargain in UK stock market
Wednesday 02 February 2005
Yet the much larger FTSE 100, which is populated by multinationals, still stands at just 71 per cent of its peak. Perhaps regrettably, the FTSE 100 accounts for 80 per cent of the total value of UK quoted companies. The FTSE 250 is just 18 per cent, so it has little impact on the overall value of the UK stock market. None the less, the FTSE 250's soaraway performance does rather explode the myth that the relative underperformance of the UK stock market over the last eight years compared with stock markets in other developed economies is down to anti-business policy by the Labour government, over-regulation, and the decision to abolish the tax credit on dividends.
I don't want to act as an apologist for the Government, but I've never found this argument convincing. The relative performance of the two indices seems finally to explode it. More than a half of earnings in the FTSE 100 come from overseas, whereas in the FTSE 250 it is only about 35 per cent. If it was Labour that was doing the damage, logically the 100 should be outperforming the 250.
In fact, the real causes of underperformance are vastly more complex. For instance, nearly a quarter of the total value of the UK stock market is accounted for by just four companies - BP, GlaxoSmithKline, Shell and Vodafone. The vicissitudes of these stocks have virtually nothing to do with the UK economy, even though all four companies are domiciled here. Rather they are ruled by forces, incompetences and sentiment that are global in nature. Three of them are in any case run by foreigners.
The FTSE 100 is dominated by sectors which are international in nature - pharmaceuticals, telecoms, financials and mining - whereas the 250 is much more domestically orientated, property, retailing and housebuilding all being sectors which performed exceptionally well last year.
There are other factors too which lead to the conclusion that the underperformance of the UK stock market is more a structural than a political phenomenon. If it were all down to Labour policy, as sometimes suggested in the City and the Tory press, then earnings would be flat or lower than they were when Labour came to power.
Since the value of the stock market has barely moved in that time, valuations should be correspondingly the same or higher. In fact they are lower. Indeed, in the 250, valuations are significantly lower. The earnings multiple on the 250 has fallen from 25 to 19 since 2002, despite the rise in the index, this because earnings have been storming ahead.
So if in fact corporate profits are rising, how to explain the relative underperformance versus the US and Europe? The abolition of the tax credit on dividends has obviously made UK equities less attractive than they were, but the more important reason in my view is structural selling by the big pension funds and life assurers.
This in turn has quite a bit to do with increased solvency regulation, though much of this is international in nature rather than imposed unilaterally by the UK. However, the bigger influence is simply the fact that the UK has a much bigger funded, final-salary pension sector than Europe. Since the late 1950s, pension funds have been substantial buyers of UK equities. Now that these funds are maturing and closing, meaning that liabilities must be matched by the "safer" assets of bonds and cash, they are wholesale sellers.
Indeed, with the retail investor still substantially out of the stock market, the only significant source of buying for the UK market is from overseas investors. Strange that it takes a foreigner to recognise a UK bargain, a fact confirmed by Office for National Statistics figures yesterday, which show inward investment by overseas investors and companies on a strongly rising trend. For them, at least, Britain seems an attractive place to be. As Labour sails towards another landslide victory at the polls, that seems to be the judgement of voters too. The reality is that the UK economy has rarely been in better shape, even if the stock market as a whole is still in the doldrums.
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