- Market volatility stalled listings through 2022
- Base rates still short of their long-term average
- Dollar strength boosts UK payments
Housing affordability – UK not quite so stretched as certain other markets
Despite the best efforts of central bankers over the past year or so, base rates remain adrift of their long-term average. Large numbers of mortgagees remain on fixed-rate deals and then there is the UK’s chronic housing shortage. Nevertheless, newspapers are chock full of articles almost enthusiastically pointing to the coming house price collapse. For the moment, UK transaction volumes have trailed off and we have seen some regional weakness, although nothing that points to an impending house price crash.
However, the boom in house prices is not synchronised across countries and we are already seeing price falls in some foreign real estate markets with the highest median price/income ratios. Average prices in Sydney, which has one of the highest ratios, have fallen by 10 per cent this year, with anecdotal evidence suggesting that property owners are increasingly willing to take a loss on resales simply to escape escalating interest rates. The unavoidable conclusion is that they should never have been granted a mortgage in the first place. The price/income ratio in the UK has been expanding at roughly the same rate as Sydney since 2015, although prices in Australia had been streaking ahead in the decade prior to this because of the commodities boom.
In terms of affordability, it’s worth noting that although the household savings ratio spiked during the pandemic lockdowns, it has subsequently taken a nosedive and is firmly in downtrend. What’s more, according to figures from personal finance site NimbleFins, median gross household savings in the UK are at £12,500, but 25 per cent of households have less than £2,100 saved – that’s sailing perilously close to the wind when interest rates are on the rise.
Inflation has been covered ad nauseum through 2022, and with good reason. But there are few signs that prices are moderating materially as we move into Christmas. Conventional wisdom has it that stocks can benefit from a brief period of inflation, assuming that increased costs can be passed on to customers. But a prolonged period of price rises will erode shareholder value if a given company’s earnings growth does not exceed the inflation rate. It can also push up the cost of capital in real terms, while weighing on sales volumes.
We will get an idea of the extent to which companies have been able to pass on cost increases and maintain cash flows (in real terms) when the year’s main full-year reporting season kicks off in February. Unfortunately, the portents are far from favourable and the trade-off between rate hikes and inflation reduction could push gross domestic product into negative territory well into 2024. It remains to be seen whether the hawkish stance taken by central banks will have a significant impact on the inflation rate given that demand for energy and food is somewhat inelastic and many of the inflationary triggers are linked to supply-side issues.
It's worth noting that inflationary effects have had a greater impact on valuations for the domestically focused FTSE 250 constituents, many of which have not enjoyed the benefits of dollar exposure in the same manner as their top-tier counterparts. There are some dire assumptions on the inflation rate priced in at this end of the market, so if you’re looking for mispriced opportunities, a focus on total returns is advisable, particularly given that dividend cover for UK equities is at a multi-year high.
Dividends in 2022 – relative dollar strength may not persist through 2023
Despite the turmoil gripping markets, the Janus Henderson Global Dividend Index reveals that global dividends reached $416bn (£339mn) in the third quarter of 2022. That record doesn’t square with the experience in the UK, although the year-on-year comparisons show that UK distributions were still on the rise when the departure of BHP from the London market is factored into the equation. The underlying figure was up by 4 per cent to £28.1bn, despite market volatility keeping a lid on special dividends.
These are not ideal times for growth stocks, partly due to their sensitivity to interest rates. But at least distributions from London’s junior markets provide a degree of solace. They have certainly grown at a much faster clip than the main market, albeit from a much lower base. Balance sheets were in much better shape exiting the pandemic than we might have hoped, while cash flows recovered rapidly. The average cover ratio of the Aim 100 constituents that pay a dividend comes in at a reasonably healthy 3.7, so there is a chance that dividend rates will hold up ahead of any capital value revival.
Dollar strength has proved highly favourable for shareholders in some of the UK’s biggest dividend payers and is expected to add a record £5.7bn to payouts this year, according to the Link Dividend Monitor. Whether the translation benefits persist through 2023 partly depends on whether the Bank of England struggles to bring the inflation rate down – even to its long-term average of 5.1 per cent. If it fails on this score, the monetary policy committee is likely to persist with its hawkish stance even if growth stalls further.
On the face of it, an increase in financing costs should act as an incentive to raise capital on public markets. That hasn’t played out this year, as global listings have slumped both in terms of volume and value compared with 2021. It’s also telling that global private equity exit-values and volumes contracted markedly during the first half of the year, led by a slowdown in initial public offerings (IPOs) following market corrections in the early part of the year. That includes a marked reduction in proceeds from special purpose acquisition companies (SPAC) in the US and a steep fall in average deal size.
Increased volatility and growing macroeconomic anxieties do not provide a favourable backdrop for any company coming to market. Private equity firms have played an important role in the IPO market in recent years, but increased volatility can undermine private equity exit strategies. And it significantly increases the chance that companies will be admitted to trading at a discount to the offer price, or even increase the average take-up by underwriters.
We can’t be sure whether UK markets will be subject to further volatility through next year, but a recent survey from KPMG suggests that IPO volumes in the UK could recover significantly in 2023. Indeed, 72 per cent of equity capital market respondents believe that numbers will rebound in the second half of next year, with a particular emphasis on the renewables sector.
