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Andy Raikes

Market Outlook

UK Outlook

Outlook
14 January 2025

By

Co-Portfolio Manager, TT Environmental Solutions Strategy; Portfolio Manager, TT UK Equity Strategy

Latest UK economic and market outlook. 

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Whilst Q4 was stable for the UK market, recent uncertainty surrounding the outlook for the UK has resulted significant volatility at the start of 2025. This volatility is creating many opportunities, with valuations even more compelling, and we believe we are very well placed as a dynamic active manager to take advantage of these.

The UK Budget was a noteworthy development during Q4. Whilst increases in taxation were well telegraphed, in the event they were bigger than expected, with domestic employers bearing much of the burden through increased national insurance contributions. For many UK domestically-exposed companies, this has caused downward revisions to earnings estimates, as those exposed have mostly quantified the incremental cost, without being able to be specific about how much of the extra cost they will be able to mitigate. However, there certainly will be some mitigation as companies will try to offset the additional costs through higher prices and cost efficiencies. Whilst several portfolio names have been impacted by this additional cost, we have continued to focus on the businesses where operational momentum and pricing power is strongest, as these companies are best placed to pass on and absorb the costs without impacting earnings forecasts. The prospect of potentially higher inflation has caused some weakness in both bond and equity markets, particularly in domestically-focussed mid-caps, as well as weakness in Sterling. The moves in the bond market have eaten into some of the fiscal headroom that the Chancellor was looking to create with the Budget, raising the prospect of further tax rises and potentially spending cuts.

With inflation potentially set to be more sticky, expectations for rate cuts have reduced, making us slightly more cautious on the domestic cyclical exposure we had in the portfolio, in particular where falling rates were a relevant part of the investment case. With that in mind, during Q4 we reduced exposure to retail and housing themes, including taking profits in M&S, Grafton, Just Eat Takeaway and Rightmove. That said, we do continue to see very significant value in UK equities, particularly in the mid-cap space, and this has become even more extreme with the indiscriminate sell-off we have seen at the beginning of January. This latest bout of weakness has been very macro driven, rather than based on company fundamentals, and as such has seen nearly all mid-caps being sold off, irrespective of whether they are cyclical or defensive, domestic or international, or long or short duration. This dislocation is presenting some very attractive opportunities in our view. Having reduced domestic cyclical exposure in Q4, we are increasingly focussing our mid-cap exposure on more defensive businesses and/or companies with significant exposure outside the UK, with the largest mid-cap positions being Serco (non-cyclical outsourcing business with significant overseas operations), Telecom Plus (defensive and fast growing UK multi-utility business), Glenveagh (Irish housebuilder exposed to the very positive structural trends in Irish housing, which are very different to the much weaker trends in the UK) and Balfour Beatty. The latter is an infrastructure construction and investments company, with exposure to the UK, US and Hong Kong. The company's UK construction activities are entirely focussed on defensive and well-supported infrastructure projects linked to areas such as the energy transition & security (grid, nuclear power, carbon capture), transport (rail & road) and defence. Its other main construction business is in the US, which is benefiting from strong trends in infrastructure and reshoring, with these drivers likely to remain well supported under a Trump administration. The valuation is also very substantially underpinned by a highly defensive infrastructure investments portfolio and a significant cash pile, which combined account for the majority of the enterprise value, implying a very low valuation for the operating businesses.

In addition to evolving our view on UK rates, we have also tempered our view about the degree of rate cuts in the US, where robust growth and the potentially inflationary policies of the Trump administration could see inflation being sticky. One relative beneficiary of fewer rate cuts on both sides of the Atlantic is the banking sector, and with this in mind we increased our weighting here, primarily through increasing exposure to more international earnings and sensitivity to US$ rates. A final dynamic worthy of mention is the recent weakness in Sterling, which will benefit much of the UK stock market, which has very significant overseas earnings.

As we mentioned above, we believe that recent volatility is creating many opportunities for dynamic active managers to capitalise on. Valuations in many high-quality UK mid-caps with strong outlooks have become even more compelling in recent weeks, and indeed the outlook for many of these stocks has improved as a result of the decline in Sterling. As well as companies taking advantage of low valuations by increasing share buybacks, we are also seeing increasing signs of a pick-up in bids for UK-listed companies, as buyers are drawn to the compelling valuations on offer, and this trend is likely to accelerate, given the low valuations and weakness in Sterling.

To conclude, we believe the UK market continues to offer a very attractive investment opportunity, with extremely attractive valuations and resilient end markets. As such, we look forward to the current year with optimism.

Important Information:

Nothing in this document constitutes or should be treated as investment advice or an offer to buy or sell any security or other investment. TT is authorised and regulated in the United Kingdom by the Financial Conduct Authority (FCA).

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