The long run-up to the Budget gave rise to fevered and increasingly alarmist speculation about its contents. This descended into chaos as frantic lobbying by interested parties, dire warnings by expert observers, and threats of rebellion by the government’s backbenchers led to U-turn after U-turn. Now, at last, the Budget has been delivered, and the speculation is over. What does it mean for the UK stock market?
The answer is very little. The FTSE 100 is very likely to continue climbing, while mid and small caps, which have underperformed in recent years, should recover lost ground. There is very little correlation between the performance of a country’s economy and its domestic stock market, which is why the Australian stock market has more than doubled in the last 10 years while China’s Shanghai index is up 10%.
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Twenty years ago, the blue-chip index was dominated by mega-cap companies that had grown big through mergers in the late 1990s but were then stagnating in terms of business, earnings and share price. Now, those companies, much diminished in relative terms, are working hard to grow, improve profitability and reward shareholders. Even Glaxo and Vodafone have seen notable turnarounds recently, while Diageo reacted quickly to disappointing trading that had halved its share price.
UK-based companies are not expecting the government to do them any favours with regard to the economy, profitability or taxation; their attitude to investing and doing business in the UK is based on pragmatism. AstraZeneca has therefore responded to a withdrawal of government support by switching its attention to the US.
Global investors spot a bargain in UK stocks
UK-listed companies are attracting increasing attention from overseas investors, who are gradually eclipsing domestic ones. In the last couple of years, the chart of the FTSE 100 has accelerated upwards, while there have been “early signs of an earnings reacceleration”, says Chris Watling of Longview Economics.
The prime problem for the UK market has been the lack of participation by domestic investors, but this is likely to change. There have been heavy net outflows from equity funds, especially from UK funds (in 50 of the last 51 months). UK investors have shunned equities, deterred by risk warnings, economic gloom and regulatory hostility, and unaware that cash loses value over time in real terms. Over two-thirds of individual savings accounts (ISAs) are just in cash.
Yet the UK savings rate is over 10%, double the historic average. Interest rates and hence deposit rates are likely to fall further, and equity markets have been rising for three years. Savers will wake up to the reality that they are missing out and, in 2026, should start to discount a change to a more business- and investment-friendly government. Finally, the attention drawn to the FTSE 100 breaking through 10,000 should galvanise investors.
Admittedly, the tenfold appreciation since launch at the start of 1984 is not that impressive in annual terms. Adding back an average dividend yield of 3%, the annualised return has been 8.5% or 5.6% in real terms. The return until 2000 was much better than subsequently, but at its millennium peak of nearly 7,000, the FTSE 100 was severely overvalued and set to fall in half. Taking this into account by estimating a trend level of 4,500 still shows a marked slowdown in annual returns from 10% in real terms before 2000 to only 3.3% subsequently.
Arguably, the change of trend coincided with the deceleration of economic growth in 2008, but it is likely that an unsustainable boom in financial services disguised a more gradual slowdown in the preceding years. In any case, the claim that Britain’s economic problems date back to the Brexit vote in 2016 are a myth, just as was the claim in the 1960s and early 1970s that Britain’s pedestrian economic performance was attributable to being outside the EEC.
Ultimately, sustained outperformance by the UK stock market will require a strong, lower-tax economy to encourage the creation of growth businesses, their access to domestic capital and their listing in London. The market needs to go up because demand for equities exceeds and pulls up supply, not because markets are shrinking (through takeovers and buybacks) faster than investors are taking their money out.
As economist Arthur Laffer points out, “every time we have raised taxes on the rich, three things have happened: the economy underperformed, the share of tax revenues from the rich fell and the poor got hammered. When we cut taxes, the reverse happened.”
Even the prime minister has said that “the UK cannot tax its way to growth”, though his chancellor and most of his party appear to disagree. “If you want to help the poor, create growth,” says Laffer, who quotes John F. Kennedy: “The best form of welfare is a good, well-paid job.”
Better economic news for the UK may be a change of government away, but the good news for investors, whether in the UK or via UK-listed funds, is here already.
This article was first published in MoneyWeek’s magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.
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