An employee looks at the FTSE stock index board in the atrium of London Stock Exchange Group Plc offices in London, England, Thursday, January 2, 2020.
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LONDON – The biggest risk to the UK stock market is avoiding an anticipated recession, according to Roger Lee, head of UK equity strategy at Investec.
The Bank of England has predicted that the UK is in its longest recession on record. Economists generally expect the country’s economic performance to be one of the worst in the developed world over the next two years.
“The biggest risk facing UK equities right now is that we don’t have a recession, and that’s probably the first time in 25 years I’ve said that,” Lee told CNBC’s “Squawk Box Europe” on Wednesday. “Because the market is already convinced that we’re going to have a recession and yet … some economic indicators, some corporate reports, would suggest otherwise.”
Most importantly, he noted, the UK labor market remains strong. The unemployment rate is at 3.7% for August to October 2022, while the number of vacancies remains at a historically high level despite five consecutive monthly declines, according to the Office for National Statistics.
“Since the post-war era, every recession in the UK or the US has been associated with significant unemployment, and we don’t see that,” Lee added.
FTSE at ‘significant discount’
His English FTSE 100 index has underperformed the most developed market partners for many years, especially in S&P 500as tech and growth stocks run rampant.
Many analysts believe that Britain’s blue chip index remains undervalued, even after slightly closing the gap after the 2022 disaster for Wall Street. The FTSE 100 is now only about 2% off its peak price.
Lee suggested that the persistent undervaluation of the FTSE, compared to the S&P 500, owed much to a combination of UK stocks needing to appreciate and the US market needing to pull back.
“Clearly the FTSE is trading at a significant discount not only to the global index but also to historical averages. The FTSE is currently trading at around 10x prospective P/E (price-to-earnings ratio) – the 20-year average is closer to 12.5x P/E, so we don’t need any significant changes,” he said.
The price-to-earnings ratio determines whether a company is overvalued or undervalued by measuring its current stock price relative to its earnings per share.
“We just need some price discounts that have been built up over the last three years to start disappearing, and I’m not suggesting that the FTSE will go up 25%, just to be clear, but the idea that there is a potential rerating of the FTSE is quite clear and quite possible,” added Lee.
“The flipside of that, of course, is the risk to S&P – especially if interest rates are higher for longer – it has not gone away.”
Higher interest rates are negative for growth-oriented stocks because the value of future earnings is reduced in today’s money. Growth stocks account for a higher proportion of the US market than in the UK
The FTSE is heavily weighted into consumer staples, financials, industrials and materials, and is known for high-value stocks from companies that pay dividends to shareholders.
“The FTSE gets a lot of bad press and there may be some justification for its composition, but here’s another stat for you: if the FTSE paid the same result as the MSCI World then the FTSE would now be trading over 9,000 points,” Lee insisted.
“The FTSE is a huge income distributor, and it clearly costs the index every year.”