UK equities: Q3 2024 market review and outlook

UK equities performed steadily over the seasonally quieter summer holiday period, and as markets went “back to school” in September.

The FTSE All-share index finished the quarter up 2.3%. Whilst this was at first glance modestly behind the S&P500 index, UK markets additionally benefitted from a strengthening of the Pound relative to major currencies. For Sterling investors, the net result was outperformance in the UK of around 2.5% compared to both the US and Japan, and of 2.1% relative to Europe.

The Fund generated a total return of 4.5% in the third quarter. The comparator benchmark, the IA UK All Companies sector, returned 2.3%, putting the Fund in the 1st quartile of peers.

We have been careful to remain true to the investment style and processes that we have used in managing the Fund over many years. So, as well as having good near-term performance, it is pleasing that Fund returns are firmly in the top decile over each of 3 years, 5 years and 10 years.

On the economic front, UK inflation remained unchanged at 2.0% in June, before rising modestly to 2.2% in July and August, with services inflation rising from 5.2% to 5.6%

In August, the Bank of England lowered interest rates to 5.0%, its first cut in more than four years. Governor Andrew Bailey noted that inflation was easing, and that the BoE should be able to reduce interest rates further, albeit gradually. Markets are pricing in a further cut of a quarter of a percentage point in November.

GDP growth has made reasonable progress in the year, albeit appears to have stalled over the summer period.

Sterling continued to rise against the dollar, taking it to a two and half year high of $1.34 on 24th September, supported by a buoyant economy and expectations that UK interest rates will remain higher than in some other countries.

The UK consumer should be feeling much better, thanks to continued real growth in wages. But for now, they lack confidence, not helped by Government statements around the need to fund a greater than expected fiscal deficit. The reasoning behind the increased deficit is open to debate, but the mix of increased taxation and spending cuts to address the situation will not be clear until the Budget, scheduled for the 30th October.

Stock selection again provided the vast majority of Fund outperformance in the quarter. The main source of value added was in Consumer Staples with meaningful contributions from food and clothing retailer Marks & Spencer, food producer Cranswick, and ingredients supplier Tare & Lyle.

Stock selection in Health Care was also particularly helpful to performance, with off-index holding in Sanofi being a strong contributor, alongside gains from Smith & Nephew.

The conviction expressed in Utilities was well rewarded – market concerns ahead of the General Election largely dissipated in the weeks that followed, and Drax ended the quarter as the biggest single contributor to portfolio performance. Overall gains in the sector were however mitigated by detraction from the holding in Centrica.

The only area of notable underperformance came from the portfolio’s overweight position in the Energy sector, the standout worst performing sector in the Index. The weak performance of the sector reflected the weak performance of underlying commodities: the price of oil fell from $85 per barrel at the end of June to $71 at the end of September.

Oil remains volatile in the face of concerns of a slowdown in global GDP. But this is set against the possible effects of stimulus in China, and against a backdrop of increasing tensions in the Middle East.

As we record this message, Brent has risen to near $80 per barrel. But even so, in our view oil remains cheap by historical standards. If we adjust for the general level of inflation, we calculate that oil would need to rise to $100 per barrel to be in line with the 20-year average. The portfolio remains overweight the Energy sector.

The fund has a positive tilt towards domestic opportunities and has significant overweights to the Utilities, Consumer Staples, and Energy sectors.

The Fund has a modest exposure to overseas precious metals and a small overweight to Health Care,

Sector underweights include Industrials, and Consumer Discretionary.

It is overall underweight Financials, however within the sector it is:

· overweight UK domestic Banks, but underweight international Banks, and

· underweight Investment Brokers, as well as Closed End investments companies.

During the quarter we exited from positions in Britvic and Next, and re-deployed cash into new positions in Bunzl and AB Foods, as well as adding to the existing position in Marks & Spencer.

Britvic had been subject to an agreed bid from Carlsberg. Next was sold after enjoying a period of sustained outperformance since we initiated a position in June 2022. Although fundamentals of the business remain attractive, the stock no longer justified inclusion according to the discipline of the Fund’s strict ‘Value’ principles.

There is always bound to be volatility in the near term. But we are very optimistic at the medium to long-term outlook for UK equities. We continue to see more interest than we have seen in many years, with increased allocations from clients in the Americas and Europe, and enquiries from across the European, Middle East and Africa region.

Irrespective of the political noise – the political world is always noisy – the UK election result has delivered a platform for stable government over the next 4 years. That stability has been lacking for some time and ought to result in growing investor confidence. Put another way, we’ve already had our election – other countries are still arguing ahead of their own.

Fundamentally, UK equities offer attractive exposure to the Value factor. Sector exposures in the UK are also very different to other global equity markets – bringing additional benefits to international asset allocation decisions, in terms of diversification.

The Invesco UK Opportunities Fund offers a clear and consistent style of investing and something that is as different as it is attractive.