For most of the past five years, both the British economy and stock market have been on the back foot. An outperforming economy became an underperforming one owing to the uncertainties generated by Brexit. Things got even worse: after the pandemic struck, GDP collapsed last year by almost 10 per cent—the worst outcome among the G7. Shares in British companies have correspondingly underperformed, trailing European and especially American equity markets. But could this year break the bad run?
The outlook has brightened markedly since the start of January, when the second and bigger wave of Covid-19 was breaking and another comprehensive lockdown had to be imposed. The curbs have been effective in controlling the epidemic, while the economy has proved more resilient than before. Above all, the success of the vaccination programme has not only helped to tame the disease but also restored some confidence in the competence of the British state.
Forecasts in April from the International Monetary Fund painted an encouraging picture of the British economy’s prospects. The IMF now expects GDP to increase by 5.3 per cent this year—almost a percentage point higher than it envisaged in January, and the third highest in the G7. That brisk tempo is projected to continue in 2022, with growth of 5.1 per cent, the fastest in the G7.
A stronger-than-expected economic bounce-back is one reason to reconsider the case for investing in the British stock market. Another is that the trade deal concluded in December with the EU, however inadequate, does at least bring some certainty after the long Brexit wrangle.
But probably the biggest thing going for the British stock market is a switch in international investing strategy. Over the past few years, the smart way to make money has been to back growth and technology stocks. That approach became even more popular last year, fuelling a recovery in the tech-heavy US stock market. Investors saw the pandemic fast-forwarding the digital economy, while the fall in long-term interest rates flattered growth stocks, by reducing the extent to which their burgeoning earnings projected over future horizons are discounted.
But as economies recover, there is renewed interest in established companies that will benefit from a return to normality and that have a track record in delivering current earnings. Meanwhile, the sudden surge in American bond yields this year has hurt growth stocks by making their more distant future earnings less valuable in present terms. This switch from growth to value stocks should favour British equities. The very thing that has caused many investors to shun the UK stock market—its abundance of old-economy shares—is now an attraction.
But a word of caution: the case for investing in unappreciated British equities has been made before, and they remained off the menu. The hoped-for economic recovery could misfire and the commercial harm from Brexit will continue. There are plenty of risks that may yet arise from a populist government and a spendthrift prime minister. In view of that, many investors will probably continue to give a cold shoulder to the British stock market, despite the strengthening argument for a warmer embrace.
