What’s next for UK equities?

We describe the opportunities and challenges facing the UK equity market in 2023.

Key points

• Although we are likely to see a recession in the UK, we do not expect it to be as deep as that of 2008.
• We expect dividends to go up in 2023.
• We think UK equities look inexpensive internationally and relative to their history, with UK valuations still depressed, particularly relative to US equivalents.
• We are starting to see value in some cyclicals, including house builders and select industrials, with the gloomy consensus economic view depressing ratings.

Although we are likely to see a recession in the UK, we do not expect it to be as deep as that of 2008. Most sectors, particularly banks and oils, are well capitalised, while health-care companies look resilient. Consequently, dividend cuts seem very unlikely, while overall we still expect dividends to go up in 2023.

The UK market is defensive in terms of its mix of ‘old economy’ sectors, with heavy exposure to oil, financials and health care. As inflation and interest rates peak and China comes out of its Covid-19 restrictions, some of 2022’s negative catalysts should ease. The Ukraine war remains uncertain and continues to constrain business confidence; however, its positive impact on commodity prices, particularly oil, is now waning.

UK equities look inexpensive internationally and relative to their history, with UK valuations still depressed, particularly relative to US equivalents.

In 2022, political disarray had a negative economic impact, as well as undermining the credibility of the UK market. We expect that to unwind, but we do not think domestic politics is key. In our view, global politics, including China/US relations and the Russia/Ukraine conflict, remains the bigger issue. It is difficult to make judgment calls around these events and geopolitics is a risk we must deal with; however, we are already discounting negative sentiment in this area.

We like financials, including banks and insurance companies. To us, they look inexpensive on a price-to-book basis and are beneficiaries of higher interest rates positively affecting their net-interest margins and income. Elsewhere, we are starting to see value in some cyclicals, including house builders and select industrials, with the gloomy consensus economic view depressing ratings.

Disruption in energy markets is likely to keep oil and gas prices high. Energy security is triumphing in terms of investment perception, easing the rating pressure on oil companies owing to fossil-fuel exposure and transition risk, while higher oil price-driven cash flows are also helping oil companies execute on transition.

Looking beyond a recession, we think there are many UK companies that are attractively valued with good yields set against an improving backdrop. As such, we think the UK stock market should fare well in 2023. Our portfolio positioning is balanced but moving towards a less defensive economic stance.

Authors

David Cumming

Head of UK Equities team