UK markets in 2023: Bright spots on a dark canvas

The UK economy has been battered by successive storms in 2022: its long recovery from Covid-19 lockdowns and restrictions were hampered by soaring energy costs, thanks in part to the Russian invasion of Ukraine.

Inflation as a whole gathered pace during the past 12 months at a pace not seen for decades. In response, the Bank of England steadily increased the cost of borrowing, with interest rates now at 3.5 per cent.

Unemployment ticked higher, house prices stumbled and household budgets were squeezed as the price of basic items rose.

In 2022, the UK saw three prime ministers, and in the last four months of the year, four chancellors of the Exchequer. Widespread strikes escalated steadily throughout 2002, as rail workers, nurses, postal workers, ambulance crews and thousands of others walked off the job. Comparisons to the Winter of Discontent of the late 1970s have been widespread.

And 2023 is predicted to be even worse. Many economists and market watchers, including those at the Bank of England, say the UK is already in a recession and predict it will stay in recession until the end of next year.

Fair shares

On the London stock market, the FTSE 100 index of blue chip companies has had a turbulent year, ranging between about 6,700 to 7,700 points. It had some knock-backs during the year, such as the war in Ukraine and the disastrous mini-budget of Liz Truss's short-lived government.

But as 2022 draws to a close, the FTSE 100 appears to be in slightly better shape. Its price to earnings ratio is about 14, which points to the UK market being slightly undervalued compared to its peers. Plus, about 70 per cent of FTSE 100 constituent firms' profits are made in US dollars, which has boosted the UK companies' bottom lines because of the relative weakness of the British pound.

As for the pound itself, it has had the worst 12 months since 2016, the year of the Brexit vote. It bounced off the all-time lows brought about by the mini-budget fiasco, but despite a recent weakening of the US dollar, it has still fallen 11 per cent over the past year.

And if the Bank of England remains on what is generally seen as a more dovish course of interest rate rises compared to its peers, the UK's currency could be in for a further pounding in 2023.

“The UK is in the vanguard for economies lurching into recession,” said John Hardy, head of FX strategy at Saxo Bank. “The combination of a heel-dragging BoE on further tightening and austere fiscal picture could set up further declines” on the pound.

Going into 2023, there is a sense of cautious optimism surrounding the UK share market.

“The FTSE 100 stands barely 5 per cent below its all-time high and it is possible to make the case for the UK’s premier stock market benchmark setting new peaks in 2023, despite the doom and gloom which prevail in the wake of Trussonomics, a sequence of interest rate increases and Russia’s invasion of Ukraine,” said Russ Mould, investment director at stockbroker AJ Bell.

“Take those into account and the FTSE 100’s performance looks quite resilient and, if anything, the best argument in favour of investing in UK equities is the air of pessimism which surrounds them.”

A recent poll by the online share trading company Inactive Investor showed that half of those surveyed believe the FTSE 100 will be higher in a year's time, with 75 per cent placing the index at between 7,000 and 8,000 points at the end of 2023. The all-time high for the index was 7,877 in May 2018.

“While we don’t know exactly what will happen next year, we do know that the UK economy will likely spend at least some of it in recession,” said Lee Wild, Head of Equity Strategy, interactive investor.

“And that’s by far the biggest worry among respondents to our poll. Recession won’t itself trigger a market crash; performance will depend on the severity of any downturn, and thinking is that this could be a long and shallow recession.

“That’s been factored into share prices already, so markets will react to surprises, perhaps to company profits, interest rates, the growth outlook or macro events.”

Broader market

Because of the multinational and dollar earnings nature of the FTSE 100 companies, most economists say, to get a clearer picture of the UK economy, one needs to look at the broader market FTSE 250 index. Here, the firms are much more exposed to the storms within the UK economy.

The FTSE 250 is down about 20 per cent in 2022, its largest 12-month fall since the global financial crisis of 2008.

Looking at some of the FTSE 250 companies builds a picture of where the UK's problems lie.

Shares in the online retailer Asos have lost 79 per cent this year, as the cost-of-living crisis tightens belts across the country.

As a rule, higher interest rates tend to weigh on consumers' online spending power and that shows in the 71 per cent slump in the shares of the online greeting card firm Moonpig, which has also had to contend with a strike by postal workers in December.

As inflation rose during 2022 and household budgets were squeezed, shares in pawnbroker firm H&T rose 60 per cent over the course of the year. Likewise, the war in Ukraine and the subsequent increase in UK government defence spending gave shares in BAE Systems and QinetiQ boosts of 56 per cent and 37 per cent, respectively.

But there were bright spots as well, which served to illustrate that, despite the UK's gloomy economic forecasts for 2023, there is money to be made in some sectors.

As international travellers piled back on to aircraft — despite thousands of flight cancellations and queues at airports during the summer — with a post-pandemic enthusiasm to go on holiday, shares in ME International Group rose 76 per cent over the course of 2022.

The self-service photo booth operator, formerly known as Photo Me, cashed in on the renewed demand for passport photographs.

Housing market cools

If the share markets could be described as having a mixed performance, the same applies to the UK's housing market.

By the final quarter of 2022, a distinct chill was blowing through the housing market. The average house price dropped 2.3 per cent in November from a month earlier, according to Halifax, the largest monthly fall in 14 years.

With interest rates set to peak at 4.5 per cent or 4.75 per cent next year, depending on who you talk to, many are predicting at least a 5 per cent fall in house prices in 2023. The estate agent Savills predicts a 10 per cent decline, as well as a fall in the number of transactions to 870,00 in 2023, from 1.27 million this year.

Meanwhile, property website Zoopla found that demand for housing had dropped by 50 per cent over the course of the year to December 2022.

House price growth is the slowest in London. However, prices in the capital are still the highest in the UK at almost £520,000, about double the UK average.

Analysts say that predicting with absolute accuracy what will happen in the UK housing market in 2023 has been made extremely difficult by the effect the Truss government's mini-budget had on the mortgage market.

Zoopla contends that the spike in mortgage rates “brought the housing market to a near standstill in the last quarter of 2022”.

While fixed-term rates have recovered somewhat from the jump of 6 per cent-plus they experienced in the wake of former chancellor Kwasi Kwarteng’s mini-budget, it has left a feeling of insecurity in the housing market.

“More discretionary buyers are stepping back and waiting for mortgage rates to come down while others still need to move now,” said the estate agent Knight Frank.

“Until mortgage rates settle, the great recalculation that will have to happen among buyers and sellers cannot take place.”

However, the recent government decision to extend its mortgage guarantee programme, whereby it offers lenders the financial guarantees needed to provide 95 per cent mortgages on houses worth up to £600,000, should provide some support to house prices.

In London, as elsewhere in the UK, the real test for house prices will come in the spring of 2023, traditionally an active time for house buyers. By then, a better picture of interest rates should have emerged and the mortgage market should be more stable.

“The resilience of prices in prime London property markets will be put to the test next spring, when activity levels traditionally pick up across the UK,” said Tom Bill, head of UK residential research at Knight Frank.

“Until then, prices should remain in somewhat of a holding pattern, although the monthly declines that followed the mini-budget have now ended.”

Dark canvas

While there are certainly some bright spots, the overall picture for the UK stock and housing markets and the economy as a whole is at best subdued, at worst extremely bleak.

Talk about a prolonged but shallow recession is tempered by speculation over a 20 per cent slump in the housing market, for example.

There is some evidence from the Office for National Statistics that household savings rates improved in the third quarter — up to 9 per cent from 7.8 per cent in second quarter. But that is balanced by the record £22 billion the government borrowed in November.

For some analysts, the key is unemployment and the labour market. As long as unemployment does not rise significantly in the UK in 2023, consumer confidence and spending can recover and household budgets, though squeezed, will not break.

On the one hand, while inflation in the UK appears to have peaked, some market watchers warn that the continuing wave of strikes will result in higher labour costs, which will add to the time the economy takes to recover.

The UK is not alone in this. Almost a million workers in Germany went on strike before the country's largest union was able to secure an 8.5 per cent salary increase. For its part, the UK government seems unwilling to enter into wage negotiations, serving only to further entrench unions' demands.

Meanwhile, both the US Federal Reserve and the European Central Bank have clearly cited the impact of rising labour costs as fundamental to their interest rate rises in the past month.

“This is the definitive battle of 2023: It’s labour versus the paymasters,” said John Vail, chief global market strategist for Nikko Asset Management in Tokyo.

“If wage hikes go through, it’ll be stagflationary and a headwind for markets, both bonds and stocks.”

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