Equity Research; 2023 Round-Up

2023 – global indices diverge

Global markets were like traffic stops over 2023 – with index divergence the key point. A quick glance show both the developed and emerging equity indices essentially all over the place. Some indices did remarkably well, others did virtually nothing, a few were bad.

In a world that is increasingly nationalistic and authoritarian, turning its back on globalization, and de-emphasizing global issues such as climate change, rising sea levels (because they appear difficult or insurmountable) going forward investors should expect individual markets to respond to local factors far more.

Americas % ∆ 1 MTH % ∆ YR Comment
US30 +5.6 +11.1 Recovers 2022 loss of 8.8%
US500 +3.5 +21.1 P/E ends at 21x +4
US Tech +4.1 +38.0 Investor demand for US$1trn cap companies
Canada 250 +2.4 +5.3 Recovers most of Toronto’s 8.5% loss in 2022
      North America remains the major source of global equity returns

 

Europe % ∆ 1 MTH % ∆ YR Comment
Euro50 +4.2 +16.4 Strong returns for EU blue chips
Germany40 +4.8 +17.9 Recoups 2022 12.4% loss, gains despite slow GDP
France 40 +4.5 +15.0 EU’s most valuable market rose 15% despite weak luxury sector
Spain35 +2.6 +21.3 Spanish index ended close to record highs
UK100 +3.4 +3.8 UK gains were ‘Xmas rally’ related, overall 2023 had considerable challenges

 

Asia % ∆ 1 MTH % ∆ YR Comment
Tokyo -0.6 +25.0 Helped by weak Yen, negative rates, rising exports, C-19 re-opening
Hong Kong -6.3 -13.2 Weak China rebound, soft tourism sector, concerns over HK’s USD peg stability
China-300 -7.0 -13.0 Weak China re-opening, slumping property market, weak consumer
Sydney-200 +6.0 +5.5 Mining weakness impacted returns
Asia Pacific +1.6 +6.2 Not bad given USD rate hike impact on region

 

Other notables % ∆ 1 MTH % ∆ YR Comment
Poland Comp +5.1 +37.2 Poland’s GDP has tripled in 30 years, major destination for EU periphery
Greece Comp +4.4 +40.3 Investor demand for EU periphery
Nigeria +4.5 +48.3 Boosted by weak Naira
Africa/ ME +3.8 +51.8 Investor demand for Middle East investments
Croatia +4.6 +28.2 GDP rose 2.7% and 7.4% drop in debt/ GDP ratio

source: CSS Investments Ltd

The index divergence in 2023 is a surprising factor given rising US and global rates/ slower GDP growth impacted everyone except Japan. What themes if any can be gleaned from 2023’s ‘winning’ indices:-

  1. Investors are keen on Middle East/ Africa as providing growth opportunities in the next decade
  2. Investors are keen on the EU’s periphery, Croatia (a really nice holiday destination I might add) Hungary, Greece, Cyprus, Poland
  3. In terms of the core EU markets, France, Germany, Spain, Italy, equity gains were similar.
  4. Tokyo benefited from the Bank of Japan retaining negative rates and allowing the Yen to weaken hence boosting the export sector.
  5. The US has been helped by significant gains in the ‘Magnificent Seven’ with the broader market helped by multiple expansion. At the start of 2023 the US500 average P/E was 17x it ends 2023 on about 21x earnings. This is a high index multiple that prices in early Fed rate cuts.

A word on China, the ‘loser’ index over 2023 which makes sense. A very slow rebound from an overly stringent lockdown, a property crisis, a tired consumer are frequently mentioned causes. But China’s GDP trajectory has been radically altered by very high youth unemployment (lots of jobless students with similar degrees) and more middle income families struggling to make ends meet.

London pedals on without IPOs

The UK had a 70’s feel to it this year, with high inflation, high interest rates and high wage settlements the prevailing factors. Higher financial costs have broadly been financed out of pay rises. The UK economy has cooled to a near zero growth rate without triggering a surge in unemployment. There is a significant productivity issue in that a large proportion of the workforce have taken extended leave. As 2023 ends the good news is UK inflation has come down sharply triggering a rally in bond prices.

The London Stock Exchange Group and wider UK listed market eco-system has faced acute challenges over 2023.

This has ranged from London’s persistently low valuations, weak institutional investor interest, to the loss of companies wanting to list in London or maintain an existing London listing. The level of discourse over this issue has become harder to ignore. There does not appear to be a remedy to this problem. Companies, especially those with significant US businesses, are being pressured to move to the US purely to obtain multiple uplift.

In terms of returns, the UK average inflation over 2023 was 8.07% however blue chip index returns were less than half this level. The UK is a ‘dinosaur’ index with old companies selling old and commoditized products, so a low multiple UK is baked in. Hence UK index underperformance is not an aberration but a reflection of low growth realities. In the last two months, Diageo, British American Tobacco and Anglo American have reminded us that the UK is not blessed with growth companies.

A linked problem is corporate migration. Over 2023, CRH, Ferguson, Flutter, Dechra Pharmaceuticals, TUI AG announced plans to either move their listing or agreements to be acquired. The loss of 30 £100m+ listed companies due to the natural attrition of M&A activity, and very large companies moving overseas if it persists, will damage London.

The UK has not replaced its leavers so the ‘swimming pool’ is draining. The UK must attract very large companies again. But this it has singularly failed to do. Its biggest IPO, Glencore was back in 2011. 2023 was interesting in terms of why IPOs did not make it or were disappointing.

WE Soda, a Turkish producer of natural soda ash abandoned plans to raise US$800m via a London listing in June, after UK investors said no to its US$7bn proposed valuation. It emerged that UK institutions were also concerned at a culture clash, and the limited boardroom and senior management interest in holding WE Soda shares at the IPO price. The company quickly withdrew from the London IPO process after being put on the spot to justify its valuation.

CAB Payments did float in July raising £335m at an £851m IPO valuation that priced its shares at 335p. The subsequent revenue warning in October, blamed on the vagaries of traded volumes in the offshore Central African Franc sent the stock down to 50p. The CAB drama was reminiscent of the Deilveroo IPO in 2001 at 390p per share, that has been significantly underwater from day one.

The September 2023 decision by Cambridge based Arm Holdings to IPO on Nasdaq with a $4.9bn raise was in my view, a foregone conclusion given the lack of a UK technology sector. Arm would have lacked a peer group had it listed in London.

Brexit has hurt London’s image, but so have ‘windfall’ taxes that the UK government tends to extract the minute an industry makes decent returns. Another big reason is increased exchange competition for IPOs. Whilst some have suggested a relaxation of the listing rules might bring in more companies, such a move would attract more low quality listings, which would likely backfire and damage investor confidence.

According to DealLogic, 2023 is the first time since records began in 1995 that the London Stock Exchange has failed to hit the US$1bn level for IPO fund raisings compared to Nasdaq which raised US$13bn in 2023. Improving the attractions of a London listing is not a quick fix and could require a decade.

Global bonds have rallied

The main cause for optimism looking to 2024 is the recent surge in US Treasuries and UK gilts following suggestions from the US Federal Reserve that rates have peaked and will be lowered over 2024. This should happen well in advance of the November 2024 presidential election to avoid accusations of interference.

The Bank of England has tried to distance itself from the discussion about rate cuts – denying conversations about cuts have taken place and managing expectations. That said, base rates should decline by at least 1% over the next year if the current inflation trajectory continues.

As investors react to declining market interest rates and pencil in base rate cuts in 2024, the bond market is expecting base rates pivot back to the 3.5% (where they stood 1 year ago) in the next 18 months. This is somewhat optimistic and the path to CPI of 2% might be more protracted if there is an election tax giveaway during H1 2024.

Gilt yields Closing YTM 1 YR % ∆ (bps) Comment
2 YR Gilt 4.07% +45 c. 1.25% of rate cuts priced into curve in 2024
5 YR Gilt 3.52% -5 YTM -61bps in December
10 YR Gilt 3.55% -1 YTM –55 bps in December
30 YR Gilt 4.10% +24 YTM -45 bps in December
      Gilt gains in December c. forward looking/ optimistic

Source: www.css-investments.com

A stronger bond market will certainly help equities and boost the UK economy, improve bank balance sheets and stimulate the property market. On that point with most banking issues on multiples of 4x-5x surely the uplift in bonds will help considerably.

Conclusion

2023 was a year when UK equities were not inflation proof against average inflation of 8.10% the UK100 returned 3.8% and once again the performance gap between London and many other markets was glaring. It is tempting to say London’s issues are temporary, not structural, that the UK will ‘catch up’ eventually. In terms of catalysts for a UK re-rating we have the prospect of lower UK interest rates and a more settled political environment. But London has serious issues that it must address. In our view this is the takeaway from 2023.

The lesson surely is that UK investors need to take a global approach. Heading into 2024 the UK faces a very important election that is likely to see Sir Kier Starmer win ‘big’. The implications of a Labour win is unknown at this point and the party have been coy about policy. Will this be another Blairite type investor friendly government? Possibly. But a big Labour win, a re-run of 1997, would reduce the rather off putting and persistent political turbulence of recent years.

Wishing you and your family a happy and prosperous 2024!

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