With the FTSE 100 currently flirting with its record high, UK stocks have made a good start to 2023, building on a strong 2022. We look at why this matters for investors and how the performance of the stock market can diverge from the ailing real economy. And, whether the UK’s biggest stocks are now overvalued after 2022’s gains.
In a sense the data is telling us what we already know: the conditions that produced a good year for the UK’s biggest stocks are persisting into 2023. In a high inflation environment, one where war drags on in Eastern Europe, UK stocks are prized for their cash-generating ability and pricing power. There’s also an element of defensiveness there too: tobacco, pharma, arms and finance stocks tend to lag in high-growth stock markets but did rather well in 2022.
In 2022 the Morningstar UK index rose by 1.24%, and while that is not an impressive figure in isolation, the Morningstar Global Markets declined by 13% last year. So far this year the UK index is up just over 4%, while the global index is up 5.21% (in dollar terms). Something similar is happening in European markets too – the Morningstar Developed Markets Europe index, which excludes UK stocks, is more than 8% higher since the start of the year after a bruising 18% fall in 2022.
Rising Tide
So this year’s rally – only a few weeks old – is more broad based. If markets can be said to have a mood, global investors are tentatively more optimistic than they were in the dark days at the end of 2022. Central bankers are holding the line in terms of hawkish rhetoric, but the data is indicating that inflation has peaked – at least in the US. Risk is back in favour, with even beaten-up Bitcoin making a recovery in January. Even the luminaries at Davos last week were cautiously upbeat given the scale of the challenges faced by the world economy in 2023.
What about the UK economy? For better and for worse, the UK’s largest stocks reflect a different reality, one of global trade. As the Bank of England’s chief economist said a few weeks ago, the UK is in an unenviable position, buffeted by global factors but also having its own unique problems.
On the ground, the UK seems in a fragile state, with ongoing strikes, soaring food prices etc. to compound the usual January blues. Life is very tough indeed for large parts of the population. But the economic data is giving some mixed signals that could encourage some potential optimism.
Bank Governor Andrew Bailey told MPs last week that we could see a reprieve in the inflation battle fairly soon as energy costs fall. He said that the country’s tight job market may be a sticking factor, but the flipside is that employment is holding up well and wages are rising (albeit below inflation). The UK economy actually grew between October and November, according to the ONS – and the Resolution Foundation thinktank argues that we may have avoided recession in 2022.
Are UK Stocks Overvalued?
After a decent two years for UK markets, investors could assume that its biggest stocks are now overvalued? Not according to Morningstar analysts. Looking at top 20 holdings in the Morningstar UK index, only three are trading above their fair value (see table). And 10 of the 20 are considered undervalued, with 4 and 5 star ratings.
We’ve also factored in price/earnings ratios, a useful measure for comparing valuations within industries and the wider market. While the 287-name index has a P/E ratio of 10.17, which is modest in historical terms, there are some stocks above – and below – this. In isolation, this just tells us that certain stocks are, unsurprisingly, expected to grow more quickly than the market, such as AstraZeneca (AZN), with a P/E ratio of 21.4. So we’ve added the 20-year average for the P/E ratio – and this shows that the current ratios are not extreme. Some big names like BP (BP.) and Lloyds (LLOY) are actually trading below their 20-year averages.
Should investors expect another good year for UK stocks in 2023? Economically, the UK faces another tough year. Markets have settled after the political chaos of autumn 2022 but the episode revealed the fragility of hitherto “safe” areas like final-salary pension schemes. Next year we may have a new party in charge of the country, at least if bookmakers odds are to be believed, which spells more uncertainty for markets. Still, corporate earnings look relatively resilient. We’ll discover more as UK stocks start reporting in the next few weeks. But markets will be more interested in the forward-looking statements.
