Insights

Concerns as London’s stock market remains in the doldrums

Global stock markets have taken a battering this week. Increasingly angry rhetoric between the United States and China has been supplemented by the threat of the US imposing tariffs on Mexican imports. A full-blown trade war looks increasingly likely. This is not a backdrop that encourages risk-taking.

Fund managers, tasked with investing our savings and retirement funds, have cut their allocations to risky assets like company shares and sought refuge by purchasing higher quantities of government debt. This has driven the interest rate on the US government’s 10-year debt down to only 2.1%, while in the UK the interest rate has dipped below 0.9%. Investors in German debt are effectively paying to protect their money with yields at -0.3%. Even Greek debt, recently a pariah in international markets, is changing hands at less than 3%. Together, this tells you that investors think that increased frictions to trade will stymie global growth, and with it the earnings potential of public companies.

Against this gloomy backdrop it is easy to forget that 2019 saw global stock markets deliver their best start to the year since 1998. Investors in a diverse portfolio of global shares are still sitting on returns of 11% since the beginning of the year and 36% since the start of 2016.

The context to this share performance is everything. But second-guessing where stock markets are heading for the remainder of the year is not the subject of this column, not least because any investment professional who pretends to know what will next come out of the US President’s Twitter account is, frankly, deluding themselves. Rather, it is an opportune moment to review what has been happening to the UK’s stock market and, crucially, what this means for the average Briton. Stock market fluctuations can often seem far removed from our daily lives, but they influence us all through a variety of channels.

A first glance at the FTSE 100 index, a benchmark made up of the shares of the hundred largest British public companies, shows it has delivered largely the same returns as a global index. The FTSE 100 is up 33% since 2016 and 10% this year. But strip out the impact of a big move in the value of the pound and the index has returned a far less impressive 14% since 2016. This is a marked underperformance for a stock market that normally moves lockstep with the rest of the world. This is despite some of the UK’s biggest companies sourcing most of their earnings outside the UK. What this tells us is that investors are calculating that future earnings of British public companies are less valuable than those listed in other regions like the US, Japan and the Eurozone.

Whether investors are right to think this – or will be proved wrong, as some of the UK’s high-profile fund managers like Neil Woodford have calculated – will emerge in the years to come. However, the longer this negative sentiment lasts, the more damage it creates.

There are three reasons to be concerned about a sustained period where UK-listed companies underperform their international equivalents. First, the lower the value of a public company the more expensive it is for that company to raise money for investment. Any sustained discount in UK valuations also encourages spare cash sitting on a company’s balance sheet to be used to buy back shares and/or pay higher dividends. This is cash that could have been used to develop new product lines. This behaviour has damaging impacts on the long-term productivity of UK companies and the wider economy. My own research suggests that the valuations of UK companies are approximately 25% below where they would otherwise be if it had not been for the political turbulence of the last three years. This discount stems almost entirely from international investors, who own 55% of UK-listed shares, taking a dim view of Britain’s prospects and cutting back their allocation to listed companies.

Second, the lower valuations now being ascribed to British companies further discourages private firms from going public and raising funds in the UK. As my Times colleague Ian King noted this week, there are already significant disincentives to become a public company in the UK. The fact that capital can be raised more cheaply in other countries presents a problem for the depth and diversity of Britain’s capital markets. This really matters. Where a company lists, operates and pays tax are linked. Fewer companies listing in the UK erodes the tax base available for the country’s public services. High-growth technology companies account for under 2% of the value of the London Stock Exchange; globally they are 14%. While there are many reasons why we do not yet have an Uber, Facebook or Google listed in the UK, one of these impediments is that much higher valuations, and by extension cheaper funding, can be achieved overseas.

Finally, one of the least trumpeted policy successes of the last decade has been the British government’s efforts to get more of us saving for retirement. Membership of occupational pension schemes has grown from a low of 7.8 million in 2012 to more than 15.1 million today. This gives a greater number of us a stake in the value of UK shares which make up a large part of these savings pots. If this discounting persists, then this will directly affect the amount that new pensioners will have available for their retirement.

So what does the future hold for the under-loved British stock market? Well, a 25% uprating in the value of British companies, as a result of some of the political fog lifting, would add about £615 billion. Now that would be a figure worth putting on the side of a bus.

A version of this piece was published in The Times.

Simon French

Economics & Strategy