By Mike Dolan

LONDON, Feb 17 (Reuters) – After such a torrid end to 2022, there may be an investment argument that it couldn’t get much worse for Britain.

While the stock market is clearly not the real economy, it’s hard to ignore the bizarre contrast of record high British blue chips and the relatively grim prospect of the United Kingdom expected to be the only G7 economy set to contract this year.

Britain dodged a technical recession late last year, but the Bank of England and private forecasters all still expect one to come down the pike later in 2023.

Double digit inflation, the highest interest rates in 15 years and a historic energy squeeze may not seem unique to Britain. But the trade and investment fallout from Brexit, variable rate mortgage exposure, tax rises to correct September’s budget mindwarp and serial public sector labour strikes through the winter are all homegrown issues.

And of course there’s always an easy dismissal of the lopsided FTSE 100 – loaded as it is with multinationals, big exporters, oil firms, miners and banks who riff more off improving U.S. and world trends, a lowly pound and rising interest rates than any change of fortune on the ground.

The FTSE 250 of mostly domestically facing UK mid-cap stocks is a better reflection of life at the coal face of the British economy. And it’s nowhere near the blue chip index.

Since Brexit came into effect three years ago, the FTSE 100 has at least managed to eke out modest 2% gain in U.S. dollar terms. The FTSE 250 however is still down almost 20% over that time, it has underperformed the FTSE 100 by 13% even priced in sterling and is still 16% off its peak from September 2021.

And while the FTSE 100 has broadly tracked Wall St and European equivalents over the past 12 months, the FTSE 250 has lagged them by 10%. More alarmingly, midcaps have underperformed the S&P500 by more than 35% in dollar terms and Euro stocks by about 25% since Brexit got done.

And if you think the FTSE100’s new record showed something stirring, look across the channel. France’s CAC40 hit a record high this week too.

“Market participants should be careful not to interpret this record threshold as a sign of a truly healthy market,” said Mike Horan, Head of EMEA Trading at BNY Mellon Pershing, adding there was also a worry that FTSE 100 dominance diverts more capital into the large caps and sees even less index-tracking passive money chase listed mid- and small-sized firms.


But surely long-avoidance of UK equity due to years of political, policy and pandemic uncertainty have made it both cheap and relatively under owned – and maybe now primed for even a snippet of good news?

Well, maybe.

Relative pricing of MSCI’s country indices shows MSCI UK almost half as cheap as MSCI US at about 10.3 times forward earnings compared to 18.7 times for the latter.

And that ‘cheapness’ may well be justified of course by anything from Wall St’s outsize share of leading big tech to a whole heap of UK currency, policy and political risk premia.

What’s more, comparisons with a forward price/earnings multiple of less than 13 for the wider MSCI Europe show UK stocks much less obviously a bargain – even if you set aside those idiosyncratic risks.

As to the ‘under own’ of British stocks, the latest Bank of America global funds survey shows an ambiguous picture too.

It said there was still a net 11% of portfolio managers declaring an underweight in UK equity. While that seems low, it was up four points on the month, about the average reading of the past 20 years and a third of the net percentage claiming to be underweight U.S. stocks right now.

Similarly, the net number of funds who view the pound as undervalued at the moment also declined. And that reading too was also near long-term historical averages – and far above post-Brexit extremes.

But if, much like dire business sentiment readings, the investment picture ahead is already as bleak as it can get, what could spark a rethink?

Not the real economy on most current trajectories.

“The UK dodged a recession in 2022 but it won’t be so lucky this year,” wrote Capital Economics’ UK team. “That’s why we expect the biggest wave of corporate insolvencies since the Global Financial Crisis.”

And yet some reckon even this gloom may already be priced.

“A lot of the news today still seems bad. But markets are saying that was priced in during 2022’s heavy mid-year falls, and the bad news is known,” said AJ Bell investment director Russ Mould, adding FTSE 100 dividend cover is at its highest point since 2012 and forecasts of a 4% dividend yield combined with the low valuations is catching the eye.

This week’s political events may have caught investors’ eyes in other ways.

While dour news for backers of Scottish independence, the sudden exit of Scotland’s first minister and leader of the Scottish National Party Nicola Sturgeon was read a couple of ways by political analysts.

Eurasia Group managing director Mujtaba Rahman’s take was that Sturgeon’s exit could both undermine the push to secession – a long-standing risk for foreign investors fearful of its budgetary and political implications – and improve the chances of opposition Labour Party in UK-wide elections due next year.

While a left-leaning governing party is not always embraced by investors, deep splits within the incumbent Conservatives and some chaotic policymaking over recent years will have many in markets viewing a change of government as positive.

And speculation that a change of governing party could also bring more progress on still-deadlocked post-Brexit talks with the European Union may also lift business moods as well.

The opinions expressed here are those of the author, a columnist for Reuters.

(by Mike Dolan, Twitter: @reutersMikeD; Editing by Josie Kao)


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