Stockwatch: why exposure to UK shares is best policy in 2024

As I have discussed in stock review pieces, 2023 was dominated by major shifts in expectations for inflation and interest rates.

Positive new year sentiment gave way by springtime to fear about the effect higher interest rates would have on economic demand and indebted companies. Cyclical stocks de-rated and growth stock price/earnings (PE) multiples contracted like they tend to do when rates rise. There were few predictable places to hide, hence frustration of prices drifting down - often without adverse change in company news. 

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The outlook for the first half of 2024 hinges on whether the November-December about-turn in expectations for inflation and rates is justified. Also, have some stocks rebounded too far? Will the delayed effect of high rates – a 0.1% slip in UK gross domestic product (GDP) during the third quarter after flat GDP in the second – mean Christmas period updates from the retail sector and year-end trading statements from other companies, give bullish sentiment a reality check? 

It appears not even the world’s leading central banker knows what he is doing. Jerome Powell, chair of the US Federal Reserve, opined variously in November that markets were getting ahead of themselves, and rates would need to stay high. Then on 13 December he ate his words, setting out the prospect for three US rate cuts in 2024.  

Equities (if mainly US) rallied again in a sense of confirmation bias. When the UK consumer price index then dropped from 4.7% to 3.9% it put pressure on the Bank of England whose governor has stuck to a narrative of rates staying high. But the Bank’s wariness looks justified given average earnings increases are at 7.3%, while the Conservatives are likely to declare tax cuts next spring ahead of a general election.  

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Contrasting with the Fed, the Bank of England “continues to judge that monetary policy is likely to need to be restrictive for an extended period of time”.   

It seems “fear of missing out” could sustain momentum into January so long as UK company updates are firm, but the medium-term economic context looks sluggish.  

What chance the Fed flip-flops again?  

In some respects, it is an odd time to embark on monetary easing: animal spirits are on the rise, equities are back near highs and unemployment is close to historic lows.  

Yet monthly consumer and producer prices published on 12/13 December hint that the Fed’s preferred inflation gauge may be returning to its 2% target.  

Perhaps Fed officials want to take a forward-looking approach so as not to further hurt the economy, given their expectation is for GDP to slow from 2.6% this year to 1.4% next and unemployment to rise from 3.8% to 4.1%. Consumer-facing businesses - where such spending constitutes 70% of US GDP - would feel some effect. 

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History suggests it is still risky for a central bank to assume inflation is effectively slain. So mind a chance of a flip-flop back to tighter policy if US data surprises on the upside. 

Will China be the real macroeconomic risk for 2024? 

With investors focused on interest rates, inflation and lately the Middle East, the situation in China has largely dropped off their radar. 

A few years ago, fears would erupt periodically of a property slump and related collapse of “shadow” banks that would bring down the entire economy and spread deflation to the West. It did not happen, and alarmist elements of the UK media turned instead to “China invading Taiwan” and threatening a Third World War. 

The China deflation story has picked up again, without much interest. Producer prices have fallen this year amid economic pressures such as a liquidity crunch in the property sector, where several developers defaulted.  

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Perhaps investors are justifiably blasé after we were told that a China crash would reverberate globally; yet somehow the strong arm of Beijing managed things through. 

Objectively though, property development is a more significant aspect of the Chinese economy than elsewhere – possibly up to 30% of GDP. Construction giants weighed down by unfinished housing projects need help to reduce default risk. A deflating housing bubble coincides also with capital outflows and falling consumer/business confidence. Overseas trade has been weak, there has been slow recovery from past Covid lockdowns, and China’s sovereign credit rating has been cut to negative. It is pretty dire.  

A risk is of China going down a similar road as Japan in the 1990s when policymakers underestimated troubles a mature economy faces once deflation sets in. Like a large vehicle whose wheels are stuck in mud, stimulus measures gain little traction, the economic wheels just spin. 

Might 2024 see mitigation of two key conflict zones? 

Equities have had to cope with major conflict both in Ukraine and Gaza. Yet the worse-case scenarios – regional spread and antagonism between the US and Russia also Iran – have been avoided. 

Negotiations under way over Gaza and possibly in due course Ukraine, could aid a sense of risk reduction – in support of equities. 

Russia’s tactic for a drawn-out war looks to have played well now US patience to finance Ukraine and supply hardware is running thin. With US attention on the Middle East, Ukraine could get forced militarily into compromise. 

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Similarly, Israel may have to step back from its declared intent to annihilate Hamas. Without providing a timeline, the White House has said Israel has assured it of lower-intensity operations as objectives shift.  

But mind a near-term risk of conflict between the US and Iranian-backed Houthi rebels attacking ships in the Red Sea – already causing stock shortages (Ikea furniture has warned) and potentially a disruption to oil supply. Freighting around Africa instead adds to costs and time. 

The pro-Hamas rebels seek to disrupt ships bound for Israel, but major transporters have paused containers anyway due to the risk. A relatively modest 5% of global shipping uses Suez to connect Asia to Europe, although higher oil prices would rekindle inflation.      

The US is in a dilemma on how to respond without escalating tensions with Iran.   

UK equity fund managers are bullish

Consensus is for decent 2024 performance for UK shares due to cheap ratings in a global context, and with interest rates set to fall. Small-caps especially are due upward mean-reversion after a torrid few years, with takeovers hinting at value.  

Sentiment has changed, where previously small-caps were seen set to bear the brunt of recession from high interest rates, the UK being stuck in “stagflation” amid low economic productivity, and Brexit delivering more by way of hurdles than hopes. I would take care given various such elements remain ongoing. 

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But yes, the valuation discrepancy is stark. After the year-end rally, the trailing PE multiple on the S&P 500 index has risen to over 26 times, which prices in more than I would expect for the global reach of major US firms. Meanwhile, the FTSE 100 index is on more like 14 times. 

A friend recently asked me whether he should follow advice to restructure his pension fund from a 90% equity weighting – 30% of which was UK – to acquire exposure to more global stocks and bonds, plus exchange-traded funds (ETFs). Neither of us could fathom what the ETFs really involved. I said it might be best to stick to what you understand, beware of portfolio churn to generate fees, and be plenty happy with a decent UK equity weighting. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.