Why have UK markets shown resilience?

The cost-of-living crisis has added £400 to an average family’s spending according to Loughborough University research.

In addition, the Office for Budget Responsibility states that the long-term impact of Brexit will be worse for the UK economy than Covid-19 (reduction of potential GDP by 4% vs. 2%).

As such many investors would be forgiven for wondering why the FTSE 100 is the strongest performing developed market in the world YTD. 

Performance Table - List of performances YTD: 

Return comparison

One key point to bear in mind when comparing the headline performance figures is the impact of currency fluctuations: Sterling has fallen 7.69% against the dollar, and the Euro has likewise fallen 5.76% against the dollar YTD. Given this, the MSCI World, S&P 500 and Stoxx 600 have fallen by a similar amount YTD. Currency does not however fully explain the outperformance of the UK market. 

There has been a long-overdue rotation from growth to value following sustained outperformance of growth stocks since the global financial crisis. Growth stocks have benefitted from the financial repression driving interest rates much lower and for much longer than anticipated, as future expected earnings are discounted at a lower rate. 

(Source JP Morgan Asset Management) 

The FTSE 100 contains large weightings from sectors that are traditionally more ‘value’ oriented than growth. It makes sense, at this point, to dive deeper into what this means from a sector perspective: 

Relative to other major developed markets, the FTSE 100 has a negligible weighting towards the technology sector, which, so far in 2022, has been a particularly volatile and poorly performing area of the market.  

This vastly reduced weighting to the high-growth tech industry makes the UK market less susceptible to large losses felt by the sector, from macroeconomic issues such as increased expectations for the pace at which central banks will raise rates.  

The macro environment

The FTSE 100 also has significant weightings towards sectors that have benefitted from the recent macro environment: financials, basic materials, and oil and gas. Financial stocks have benefitted from the rising rate environment, while basic materials have benefitted from shortages caused by ongoing effects of the pandemic and the outbreak of war in Ukraine. Prices for oil and gas have risen dramatically since Russia’s invasion of Ukraine, with global supplies being significantly reduced and Europe facing an energy crisis if it chooses to stop using Russian power sources. 

The FTSE’s 100 lack of tech exposure is not merely an accident of geography, the London Stock Exchange has stringent requirements for companies to list on the market. This is an attempt to ensure that the companies listed on the exchange are more likely to be of higher quality and have strong financial metric and balance sheets. This also means that the fast-growing high-tech companies are less likely to list in London than comparable indices in the US. 

A key reason that the UK market has outperformed European markets is because the European Union is at a greater direct threat from Russian aggression and significantly more dependent on Russia than the UK for oil and gas. Before the Russian invasion of Ukraine, the EU imported around 40% of its natural gas from Russia, compared to only 5% that was imported by the UK. 

For oil, the EU imported more than 25% of its oil from Russia, whereas the UK imported only 8%. Proposed sanctions on Russian exports have therefore caused significantly more disruption to European countries than to the UK. Brent Crude oil has risen by more than 17% since the outbreak of war in Ukraine. Also, the ensuing energy crisis has caused inflation estimates for Europe to drastically increase, and negative sentiment to fall, upon European equities and the wider Eurozone economy. 

The Russian invasion has also caused shortages of several key commodities and crop inputs, for example potash, of which Russia and Belarus were the largest exporters, accounting for roughly 40% of global potash exports. Sanctions on these countries has led to uncertainty over supply of potash and seen a dramatic price increase.  

The shortage of key commodities led to a rapid price increase across a basket of commodities, as global demand increases, and fears of a long-term shortage heighten. The Bloomberg Commodity Index has risen 33% so far in 2022. This affects both food inputs and crops as well as materials. 

A lot of the causes of these market dynamics that have led to the outperformance of the FTSE 100 YTD appear to be structural in nature and could presage a longer-term advantage for the UK market relative to peers following a multi-decade underperformance for UK stocks.  

It will certainly be interesting to see how these market dynamics play out across the rest of 2022 and beyond. 

Sources 

• https://www.theguardian.com/business/2022/may/23/costs-for-uk-families-with-two-children-rises-inflation#:~:text=The%20cost%20of%20basic%20goods,inflation%20than%20official%20figures%20indicate. 
• All data points sourced from Refinitiv 
• https://www.gov.uk/government/statistics/dukes-foreign-trade-statistics 
• https://www.politico.eu/article/eu-sanctions-higher-food-prices-potash/