Equities are set to receive a boost this year as central banks’ eagerly anticipated programme of interest rate cuts begins and investors latch on to the benefits of a positive rate environment and the ebbing of the inflation whirlwind.
Indeed, analysts at Liberum expect markets to rally from Q2 onwards for most of the year, underlining the fact that when starting valuations have previously have been as low as they are now in the UK and Europe, investors were almost certain to achieve double-digit positive returns in the three to 10 years after. Barring the materialisation of certain risks, the broker estimates that UK and European equities will see double-digit returns per year (with real returns of around 6 per cent a year in the UK) in the decade to come. Small caps should, as they always tend to do when rebounds come, outperform large caps. Trailing 12-month price/earnings ratios show that the FTSE Small Cap index is trading at a discount of 45.7 per cent to the post-1996 average.
If buyers do emerge for downtrodden, unloved London shares, and there is even more reason to believe they will if rumoured plans for a UK Isa turn out to be true (a development we would wholly applaud), it will be a relief to anyone who has been at the receiving end of the ongoing liquidity drought. Retail and institutional investors have been discarding their domestic shares for a variety of reasons – the headwinds companies are exposed to in a problematic macro environment, the expectation of mediocre returns, the strong appeal of bonds, cash and US shares, the lack of exciting technology companies and interesting new arrivals, stretched income in a cost of living crisis – a net £22.6bn was withdrawn from UK funds by retail investors alone in the seven quarters up to the end of September last year according to the Investment Association – and the huge shift in asset allocation and geographical make-up of pension fund portfolios.
The situation is not helped by takeovers reducing the number of listed companies, resulting in a lack of choice for UK investors, a reduction in overall quality, and companies that might have graduated to the FTSE 100 disappearing off the market forever. But who can blame the fed-up owners waiting for value to be recognised? High deal premiums being paid reflect the bargain valuations available to acquirers.
The UK has always attracted foreign bids but in recent years the acceleration in the number of companies being picked off alongside a dearth of new joiners has led Peel Hunt to describe the pace as relentless, and the situation as one to be mourned. There were no IPOs in the last quarter of 2023 unless you count a transfer from the Aquis exchange to Aim. The last time things were this quiet was in the first three months of 2009 when markets were in the grip of the financial crisis, says UHY Hacker Young.
There is broad agreement that takeover activity, having slowed down in Q4, will rebound in 2024. And while rate cuts are sure to lift share prices, they are likely to impact domestic listed companies in another way, too: by increasing the chances of bids being made for them. That’s because cheaper debt will pave the way for a new spate of takeovers, with British companies likely to be top of buyers’ lists given their lower relative valuations. And while larger and more ambitious acquisitions may have been ruled out last year because of the cost of financing debt, that deterrent may gradually cease to apply. There may be rewarding times ahead for some even as the ranks of companies are thinned out further.
But there could be a twist in the takeover tale, which is that a dramatic acceleration in the stream of exits in itself could be a significant powerful trigger for share price gains as investors recycle their capital back into the market. “A fund manager will likely redeploy that capital back into the companies they hold and know best … Quite quickly the whole cycle of the negative doom loop can start to corkscrew back the other way,” says Dan Webster at Peel Hunt.
Webster acknowledges that this would only be a short-term phenomenon, and not something that could solve London’s capital crisis: it won’t work, he says, if the outflows out of UK equity funds keep going. Yet it might be an important step with predators “actually playing a vital role in acting as a defibrillator for capital markets”.
There may be a glimmer of light down the IPO tunnel too with companies expected to revisit their float plans as conditions improve, and as a queue of private equity houses seize the opportunity to exit mature deals via flotations.
