Despite the liquidity squeeze ‘the only way is up for UK equities’

Published on 19 February 2024

Tim Lucas at Newton Investment Management

Tim Lucas, UK equity fund manager and research analyst at Newton Investment Management, discusses how his firm navigates the challenging liquidity environment in UK equities and the struggling primary markets.

Despite the liquidity squeeze, the equity head says ‘the only way is up for UK equities’ in 2024 and sees positives in UK companies publicly listing elsewhere such as the United States.

In this episode, Lucas also provides his views on earnings this week; where he’s finding opportunities in the property market; how he predicts inflation and the Bank of England interest rate decisions to play out over the coming months; and looks at how fiscal policies and global elections could impact volatility this year.

North America: Weekly Review and Outlook

  • Equities volumes climbed but liquidity was lower week on week.
  • US investment-grade volumes continued to climb and liquidity has improved marginally week on week.
  • Data: Canada’s Inflation rate on February 20, US mortgage applications on February 21, and US Initial Jobless Claims on February 22. Earnings e.g. Walmart and Nvidia.
  • In primary equities: 5 IPOs expected to price this week at $112 million. The largest should be MRF 2024 Resource Limited. Partnership at $37.4 million.

Europe: Weekly Review and Outlook

  • Equities volumes fell week on week, yet were high for historical ranges. Liquidity was poor.
  • Euro investment-grade volumes cooled off, but liquidity appeared good.
  • Data: EU Inflation Rate on February 22.
  • In primary equities: No IPOs expected on European exchanges this week.

Transcript of interview

Jo Gallagher: Welcome to Trader TV this week – your insight into our trading desk and prepare for the week ahead. I’m Jo Gallagher. Today I’m joined by Tim Lucas at Newton Investment Management to discuss main topics and events leading this week. Tim, welcome to the show.

Tim Lucas: Thanks, Jo. Good to be here.

Jo Gallagher: Before we begin, let’s take a quick look at last week’s activity and what’s coming up.

In North America last week’s US equities volumes continue to climb, edging higher week on week and moving just above historical averages for the past two years. Tuesday saw a panic sell off in stocks due to hotter than expected inflation data, yet markets rebounded from midweek onwards. Liquidity showed little difference week on week, but bid-ask spreads have gradually widened since the beginning of the year.

Last week, US investment grade volumes continued on their high streak and particularly gained momentum in the second half of the week as markets seek to benefit from the high interest rate environment. Liquidity showed a marginal improvement week on week, but spreads are ranging close to historical averages seen for the same week in 2020 and 2022.

This week will be relatively light in terms of data, but markets will be keeping an eye on changes to Canada’s inflation numbers on Tuesday. The latest figures on US mortgage applications on Wednesday and initial jobless claims on Thursday will have a fresh batch of earnings this week, including reports from major retail heavyweights Walmart and Home Depot and the eagerly anticipated results from chipmaker Nvidia. Primary equities seem to be picking up in the US, as there are five IPOs expected to price this week at $112 million in aggregate proceeds. The largest deal is expected to be MRF 2024 Resource Limited Partnership, which is seeking to raise $37.4 million.

In Europe in the UK, last week saw equities volumes drop off substantially, putting an end to the extremely high activity seen since the final week of January. Yet levels were still elevated compared to historical averages for the last two years. Liquidity was poor last week relative to the same period for the last five years, and bid-ask spreads have continued to widen since the beginning of 2024. Last week, euro investment grade volumes fell substantially week on week, but levels remain high relative to the past four years as investors continue to lock in favorable yields ahead of interest rate cuts. Despite the drop in volumes, data showed a continued improvement in average daily liquidity over the last two weeks.

Markets across Europe will have a quiet week in terms of data, but will be awaiting the latest reading on the EU suppression rate on Thursday in earnings. Equities traders across the region will have some fresh results to sink their teeth into, including reports from Barclays, HSBC, Glencore and Rio Tinto. In primary equities, we can expect no IPOs to price on European exchanges this week. Yet some late listings did come through last week, raising $68.5 million in aggregate proceeds.

Tim, we will be focusing on UK equities in this conversation. Put this week into context for me. What will be driving trading decisions and what might impact equity?

Tim Lucas: Well, this week we have a lot of company results coming out of the UK market. So that more than anything else, is likely to be driving the liquidity and the majority of the share price movements. Two of our largest share holdings, for example, Lloyds and Barclays, the large banks are reporting. Now we’re hoping that profit targets will be more or less maintained at the current levels. If that happens, then the shares will be strong because the market is expecting declines.

We’ve also got some interesting economic data coming up. Public sector borrowing on Wednesday and UK consumer confidence data on Friday. Now UK borrowing number is quite important because we’re expecting this to be pretty strong. The government is likely to have borrowed a lot less than what it originally thought, through having higher wages from the people it’s taxing over the last year or so. And so it’s collected more tax than it expected it would do. And in addition, the debt servicing costs have reduced because inflation has been lower. And they have a large amount of index linked gilts within their debt portfolios. So it’s likely it’s going to have around 10 to 15 billion pounds more money than it thought it had, which is great news for all of us, because probably in the budget it will be looking to cut some taxes somewhere and that’ll be a boost to consumer incomes.

Consumer confidence on Friday has been rising for the last few months and we expect that to continue. Again we’ve had falling inflation, rising wages. So that should be very positive for consumer facing sectors such as airlines, pub companies, restaurants, that sort of thing.

Jo Gallagher: US tech has dominated global equities for the last five years. What is the business case to be investing in UK equities?

Tim Lucas: Simply put, UK equities are really, really cheap. They haven’t been bought for the last 5-10 years by many people. And so they’re now trading 30% more cheaply than the US market, which is a bigger gap than has historically been the case. You’re looking at ten times forward earnings on a 12 month basis, and the best time to buy equities is when other people aren’t.

It’s not only the case that they’re cheap, but we actually think in the UK that things are really getting better now. Last year, wages increased by 7%. This year we expect another 4.5% wage growth. However, more importantly inflation is falling. So whereas inflation was at 7% last year. This year we expect inflation to fall down to no 2 to 2.5%. Key to this will be the announcement of the energy price cap on 23rd of February by Ofgem. We expect that to fall by around 15% and if this happens to be the case, then we will see not only more income for consumers, but secondly, the likelihood that the Bank of England has room to begin to lower interest rates as we go through the year.

One area we’ve been looking at is retail property. We own land securities that owns offices and retail space, and with that company you get a 6% yield, which is attractive in its own right. But we think that should begin to grow as rents can begin to move up as more people spend money in the shops. In addition to that, as rates begin to come down, that should look even more attractive in the eyes of investors. There’s a 6% yield would be much better than what you can get, either in the bank or in bond markets.

Jo Gallagher: Globally, election counters and fiscal policy will be a major cause of volatility this year. Do you see that being the case for the UK? And how will that inform your investment strategy?

Tim Lucas: Well over the last few years people have thought that the UK is, you know, terribly unstable. We’ve had Brexit followed by several different prime ministers in short order. But looking to the future, we think it’d be rather different. We’ve got a choice in the coming election between Labour and the Conservatives and to be honest, their policies look much the same. It’s another reason why the UK is attractive. You don’t really have to worry about political risk.

In the US there is political risk so very difference. You know, Trump and Biden could not be more different if they tried. If Trump gets in, all the green infrastructure policies will likely be pulled and he’ll probably concentrate more on reducing personal and business taxation, which would result in very, very different leadership in the equity market, leading to volatility. But in general politics in the UK, a bit of a sideshow. The important thing is the improving economy.

Jo Gallagher: Liquidity has been challenging across UK equities and there’s been a drought across the IPO market. How have you been able to navigate this challenging environment?

Tim Lucas: Well liquidity and also valuations of UK equities have fallen really as institutional investors, particularly UK pension funds, have disinvested from the UK equity market. And that’s happened over many years. The good news is that this has now stopped as basically these pension funds do not hold any UK equities anymore. So liquidity and valuations should not go massively lower from here. So from that point of view we don’t have to worry about it.

However, IPOs in the UK market are unlikely to return until valuations increase. Nobody wants to sell their business for less than what they think it’s worth. So it’s much more likely that you will have IPOs in the US. And indeed one thing which could happen, which you have seen a bit of already is that UK companies could delist from the UK, move their listings to the US in search of higher valuations, and that is actually something which could benefit your portfolio because as people do move, as companies do move, their share prices are likely to go up. We’ve seen that with Ferguson Group last year, and we’ve seen it more recently with CRH, the building materials company, and Smurfit Kappa is going through that process as we speak. So one way you could get higher valuations out of UK equities is through the listing elsewhere. We think that perhaps another way is because of the very low valuations and the fact that the companies in the UK are very well run, that they’re attractive acquisition targets for overseas companies or for overseas investors. Liquidity ought to improve as overseas companies and investors start investing again within the UK. Either way, the outlook is positive. UK equities are cheap. The biggest seller of UK equities pension funds is exhausted and so it’s not able to sell anymore. And things are getting better in the UK. So really from here the only way is up.

Jo Gallagher: Thank you Tim for your insight and thank you for watching.

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