Exciting times for UK Equities?

In contrast to many countries, the UK has entered a period of relative political stability. Simon Gergel describes how this is combining with other factors to signal a note of optimism for investors in the UK stock market. Simon and host Jon also discuss how Merchants has been positioned to try to capitalise.

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JC: Hello and welcome to A Value View from The Merchants Trust. Thanks for joining us. Now, the objective of this podcast is a simple one. We aim to bring you insight and views on some of the biggest current investment issues of the day, and we'll do this as we always have, by looking at it through the prism of The Merchants Trust, which boasts a diversified portfolio of large, well-established and well-known UK-listed companies. So, who better to guide us on this journey than Simon Gergel, Portfolio Manager at The Merchants Trust. Simon, it's good to be with you again.

SG: Hi Jon, nice to see you.

JC: Well, very good to see you and, Simon, 2025 is upon us. In the UK and, indeed in much of the rest of the world, the political and economic landscape has shifted considerably from just a year ago. The New Year promises to be something quite different from 2024. And as far as the UK goes, are we perhaps witnessing the start of something special? So, Simon, what's your view? How attractive is the UK market at the moment?

SG: That's a great question, Jon, as we come to 2025. I think it's a really exciting time to be an investor in the UK equities. We start from the starting point often is where is the market in terms of valuation? The valuation of the market is well below long-term averages at a time when many other markets are quite highly rated, so the UK is clearly out of favour. We've seen large outflows of money for many years for different reasons. But I think we're at an interesting point because things are changing, the political cycle has changed. We now have a government with a firm majority and the government looks pretty stable in the UK, which is in contrast to what we're seeing in many other countries, particularly on the continent, but also in America, where there's a lot of political uncertainty. We're seeing interest rates starting to come down. We're on a cycle of rates declining; we are seeing inflation has returned to normal. Companies are generally performing pretty well, and we're seeing the economy recovering, albeit modestly, but we're seeing the economy coming through, so cheap market, stable environment, a lot of the reasons for avoiding the UK I think have fallen away. And we're seeing a lot of takeover activity coming into the market as well, so yeah, a really interesting time.

JC: OK, I want to come back to that point on interest rates shortly, but just to your point on political stability, the broader environment here in the UK. Is it that stability? Is it the knowledge that there is a government with a large majority that settled markets, or is it anything to do with policy?

SG: Well, I think you have to be aware of policy. I think policy is not that different to what we thought the Labour government would do when they came in, there's clearly details that are different. I think some of the taxes on national insurance and so on on Labour maybe a little bit higher, but essentially we have relatively solid stable policy, and predictable policy, hopefully.

JC: That's the thing, isn't it, predictability. Markets like predictability, don't they?

SG: Absolutely, and if you look at the fact that you've got general elections in France, you've got a lot of uncertainty in Germany, you've got an uncertain, nobody quite knows what's going to happen with Donald Trump in America. If you then look at the UK, we've got a pretty good idea of what policy's going to be for the next few years, subject of course to external events which are always unpredictable.

JC: Well, like we said before on this podcast, we want a period of, and it looks like we hopefully will have a period of, a government being reassuringly boring.

SG: Yes, and we're hearing that from other investors outside the UK now. They're starting to say, doesn't the UK look interesting from a political stability point of view, which we haven't really heard for a while.

JC: And you talk, and mention as well, that takeovers and buybacks are back in vogue. So, expand on that a little bit more.

SG: Yeah, so often we get the question, who's going to be buying the market because it's been out of favour for so long, but we're seeing a huge number of takeovers of companies, I think in the first 9 months of last year, there were 19 bids for FTSE 350 companies. So, of the largest 350, 19 were bid for, which is clearly a very large proportion in a short time and that's just the larger companies. We're also seeing a huge number of buybacks, something like 40 to 45 billion pounds a year at the moment is the annualised rate, that's equivalent to about 1.7% of the UK stock market, similar to the market cap of a company like Compass, for example, so a big company. One of those has been taken off the market each year by companies buying back their own equity. So, there is a big buyer for the market, and at any, at the point in which investors stop selling the market, then the share prices should start to go up and could move up very rapidly if anyone actually wants to buy the market, you know in aggregate because there are these other buyers there as well.

JC: Now, you mentioned that the UK market has been cheap for some time, that's been a theme that you and I’ve discussed on many occasions. If prospects though are improving, how long can this last?

SG: Well, I think it's always hard to say when things are going to happen, how long they last. History would suggest that if you buy the stock market on modest valuations, you generally get a good return over the subsequent 10 years. Now, that can come within a year. It can come later on. We don't try and predict that. What we try to do is find individual companies which are offering good value that we can buy and aim to get a good return in the medium to long term. We’re very confident the companies we can buy out there in the valuations, and the market in aggregate is interesting, and actually more than that, there's a big dispersion in the market, so the companies we buy typically are at significant discount to the overall market. If you can buy companies like that, lock them away, get a good earning, good income stream, I think that's a sensible place to start.

JC: OK, now, you mentioned interest rates earlier on. They have been falling, but perhaps not as fast as some might previously have thought. So, what's your view on how rates will play out in 2025?

SG: Yes, that was probably the biggest surprise or one of the biggest surprises in 2024, is that interest rates didn't come down as quickly as many people thought they would. I think the important thing is they are on a down trajectory. Inflation seems to be under control and at a modest level, and therefore it's likely the interest rates continue to come down. And that supports the economy and the markets in various ways. I mean, firstly, the cost of borrowing for companies goes down, so companies feel like they might be more inclined to invest. Cost of mortgages goes down for consumers, consumers might have more money left in their pocket at the end of the day, and also the discount rate, theoretically for investors goes down and so the yield they demand from investors investments go down and as yields go down, valuations can go up. So, there are lots of reasons why lower interest rates should feed through to a higher market over time, subject to all other things like where evaluations are.

JC: Yeah. And, of course, where the Bank of England's monetary Policy Committee is as well. Do you think that perhaps they'd be, perhaps guilty of an abundance of caution when it comes to interest rate policy at the moment?

SG: They can't win really, can they? They're either too slow or too quick, and it's a very, it's a very tough job, perhaps interest rates were kept higher than for longer than they needed to be, but it was difficult to call. Maybe they're coming down a bit too slowly, but I don't think it really matters as long as we end up in roughly the right place, whether it's 3 months, 6 months, earlier or later, probably isn't critical. The economy's not growing. very fast, but equally it's not crashing into a recession, at least it doesn't seem to be.

JC: OK. Well, let's just put this all into perspective then for The Merchants Trust. How is the Trust position to capitalise on the situation in the UK that you've been explaining to us, you know. Which sectors are you particularly interested in at the moment, when you think ahead to 2025 and how do you plan to make the most of those opportunities?

SG: Yeah, well, one of the interesting things about the market is actually there's value in many of the sectors, it's not just concentrated in a few select sectors. So, they're within many sectors you'll find a collection of quite highly rated companies that don't look very interested to us… interesting. And a collection of quite lowly rated out of favour depressed stocks where there may be some good value. So, we are finding value in a number of different sectors. If I had to highlight the most interesting areas, we like the reinsurance stocks. We like a lot of the companies involved in the building and construction area. I think the government have got this plan to build 1.5 million houses. I mean, it's a very ambitious target, it's not that realistic, but it doesn't really matter. What matters is they’re good for investors, is they're going to push the button, free up the planning and hopefully activity in the housing market will pick up, which is good for companies making building products and furniture and, you know, distributing building products and so on. Those are some of the areas - retail, we've got some investments, real estate looks particularly interesting at the moment with big discounts to asset values in many cases, so we're seeing value in quite a number of different areas.

JC: OK, well, it's an optimistic note then, I think, that we look at 2025 with, as we look into the year then, Simon.

SG: Absolutely, I think where we start the year, the valuations look modest. We had a decent year in 2024, but we are optimistic for the future, yeah.

JC: Well, it's good to hear, and as ever, it's been a pleasure to spend a bit of time with you, Simon, to discuss those factors. Unfortunately, we're out of time but thank you very much indeed.

SG: Thank you, Jon.

JC: And thank you for listening to A Value View from The Merchants Trust. You can find out more about The Merchants Trust and read and watch Simon's latest investor notes by going to merchantstrust.co.uk. Thanks for listening. And until next time, from all of us here at The Merchants Trust, it's goodbye.