As Thursday’s election approaches, multiple narratives are interweaving and the UK stock market is set for a very eventful second half of the year.
The UK situation feels more complicated and contradictory than the US, where the continued dominance of the “Magnificent Seven” – and Nvidia in particular – has made the first half of 2024 all about technology.
Here in the UK, where GDP is stagnating but share prices are at record highs and serious discussions about IPOs and M&A have resurfaced, a disconnect has emerged between the real economy and the stock market.
British companies from a range of sectors have emerged as potential takeover targets, including food delivery company Deliveroo (ROO), mining giant Anglo American (AAL), and financial services company Hargreaves Lansdown (HL).
With opinion polls predicting a landslide victory for the Labour Party in the July 4 election, the political commotion is becoming harder to ignore as the six-month campaign period comes to an end. A first interest rate cut from the Bank of England is expected, likely to take effect on August 1.
Abbie Glennie, deputy head of small and medium-sized companies at Abriddon, lead manager of the Morningstar Silver-rated Abriddon UK Mid Cap Fund and co-manager of the Abriddon UK Small Business Fund, previously told Morningstar that the FTSE’s rise in the first half of the year was mainly due to the UK regaining favour with foreign investors. GDP for the first quarter of this year was revised upwards to 0.7%, and the IMF predicts it will grow by double that in 2025.
Over the past six months, the FTSE 100 has risen 6% to 8,189 points on the last trading day of the quarter, driven mainly by hopes of an improving economy and an end to the great mergers and acquisitions slump, while the Morningstar UK index has risen more than 7% in the period.
“One of the downsides the UK has faced in recent years is that it hasn’t had as much exposure to artificial intelligence as the US market,” Glennie said.
“However, we are currently in a good cyclical period with a significant number of industrial and domestic cyclical stocks driving the UK market higher.”
Which UK stocks have performed best in the first half of 2024?
Rolls-Royce Holdings (RR), the narrow-moat aerospace and defense company, was the best-performing FTSE 100 stock in the six months to June 21, 2024.
The company’s shares rose 57.9% during the period to a record high of £4.76, beating Morningstar’s fair value estimate, which remains at £3.80.The company, which makes many of the world’s jet engines, has benefited from a surge in international travel since the pandemic, but rising geopolitical tensions have provided a tailwind for the defence sector.
NATO allies continue to pledge increased military budgets to counter the Russian threat, a move analysts predict will only boost British defense companies such as Rolls-Royce and BAE Systems (BA).
The financial services sector also performed well, with Hargreaves Lansdown (HL), NatWest Group (NWG), Barclays (BARC), Intermediate Capital Group (ICG), and Beazley (BEZ) all ranking among the top 10 for year-to-date returns.
Bristol-based brokerage and fund supermarket business Hargreaves Lansdown saw its shares soar when news of a potential buyer made headlines in May, and they have continued to rise since then.
While the final outcome of the private equity consortium’s deal that will see the company delisted from the FTSE 100 has yet to be revealed, the development offers a ray of hope for the company’s shares, which have been struggling since the Neil Woodford scandal broke in 2019.
Meanwhile, ICG reported an increase in pre-tax profits, while major banks NatWest and Barclays benefited from growing personal deposits and interest rates remaining “high for a longer period”.
Which stocks are taking a beating in the first half of 2024?
Meanwhile, UK cyclical consumer stocks struggled amid continued concerns about the cost of living.
Entain (ENT), Burberry Group (BRBY), JD Sports Fashion (JD) and Whitbread (WTB) were the poorest performers in the FTSE 100, falling 32.4%, 30.4%, 23.7% and 17.6%, respectively. Non-essential spending took a hit, as did the companies themselves, as rising inflation put a strain on finances.
But they were not the ones who suffered the most.
Ocado Group (OCDO) was the worst-performing stock in the FTSE 100 in the first half of this year, with its share price falling 58.9%, according to Morningstar data.
The company’s poor performance has led to its relegation from the FTSE 100 index and is blamed not only on the cost of living crisis itself but also on increased competition in the already competitive UK grocery market.
Who has the UK’s strongest dividend?
Dividends have been strong in the first half of the year, and in our latest roundup of the top FTSE 100 dividend stocks we’ve highlighted four companies set to see dividend increases: Imperial Brands (IMB), BT (BT.A), HSBC (HSBA) and AstraZeneca (AZN).
Of these, AstraZeneca’s latest dividend of £2.47 per share is its highest in the past five years and represents a 7% increase on the dividend it paid in 2023. The company paid £2.02 in 2021. Imperial Brands (IMB) and BT (BT.A) are also expected to pay £2.24 and 56 pence per share respectively in September, up from the £2.16 and 54 pence paid respectively in the third quarter of 2023.
“The dividend picture for UK equities is reasonably healthy,” says Mark Preskett, senior portfolio manager at Morningstar Wealth.
“Among the top 50 listed companies by market capitalization, [FTSE 100]In the first five months of 2024, only six companies saw their dividends decrease compared to the same period in 2023.
“With the average increase rate being around 9%, it is not unreasonable to expect mid to high single digit dividend growth from the FTSE over the course of 2024. This is a much brighter outlook than at the height of the Covid-19 pandemic, when dividends in UK shares fell by 40% year-on-year.”
Apart from dividends, UK companies continue to buy back their own shares, a much-debated practice. Share buybacks mean that companies can distribute profits to shareholders without being bound by dividend commitments, further increasing earnings per share.
But buybacks raise other questions: Are companies buying back their shares at a fair price? And, more importantly, are the funds companies allocate to buybacks starving other companies of important capital spending for other projects?
“The increase in share buybacks in the UK has been very significant,” Preskett said.
“Twelve percent of large UK companies bought back at least 5% of their shares in 2023, compared with just 9% of US companies.”
Which UK companies are being targeted for acquisition?
The bid for Hargreaves Lansdown is an example of a resurgence in mergers and acquisitions activity.
“The surge in UK M&A activity expected in 2024 is another sign that the UK is undervalued,” Preskett said.
“According to the UK Office for National Statistics, M&A sales by UK companies exceeded £10 billion in the first quarter of 2024, the second highest quarter since 2000. The second quarter saw more activity, including a bid for PE-backed giant Hargreaves Lansdown.”
Richard Marwood, portfolio manager of the Morningstar Gold-tagged Royal London UK Equity Income fund, told Morningstar that UK M&A is again impacting larger companies.
“Companies themselves are buying back their own shares, that’s the driving force, but we’re also seeing more M&A activity,” he said.
“It started out in a smaller part of the market, but we expect to see a much larger range of capitalization in 2024.”
Potential targets for this activity (and their bidders) are listed in the table below.
London-based mining giant Anglo American (AAL) recently faced a takeover bid from BHP Group (BHP) that was later rejected, while paper and packaging brand DS Smith (SMDS) also agreed to a £5.8bn acquisition deal with larger US rival International Paper (IP).
But while this is exciting and likely to benefit shareholders who are in the right place at the right time, it’s not necessarily good news.
“The real question is how acquisitions and buybacks shrink the market,” Marwood said.
“There is a little bit more evidence of established companies raising a bit more capital, but the overall trend is that the UK stock market is shrinking.”
This means that new entrants are needed to step up more than ever. In this sense, the announcement that Chinese fast fashion giant Shein may list in London (which would add more than $60 billion in shares to the FTSE 100) could be a promising development.
Cambridge-based computer company Raspberry Pi (RPI) debuted on the FTSE 250 index in June at a valuation of £542 million, marking a smaller UK public market listing. But its IPO added to the narrative that listings, at least in the UK, aren’t stalling. The company’s shares rebounded on its first day of trading. Investors can only hope that neither company ends up in the same situation as Deliveroo – listing, underperforming, and becoming the target of a takeover bid.
Other notable acquisitions include Carlsberg (CABGY) proposing to buy British soft-drinks maker Britvic (BVIC), but the initial bid was rejected due to valuation.
When will the Bank of England cut interest rates?
Much will depend on what the Bank of England does next. While rising interest rates have benefited retail banks, higher borrowing costs are making life harder for both businesses and their consumers.
Late last year, many analysts were boldly predicting several rate cuts in 2024, but none have actually come to fruition. But as the saying goes, it’s only a matter of time.
Clive Beagles, portfolio manager at the Morningstar Gold-rated JOHCM UK Equity Income Fund, said he was surprised the Bank of England didn’t cut interest rates in late June, though he believes there will be fewer cuts anyway now that economic conditions are more favorable.
“Two or three [cuts] And that may be it,” he says.
“That would be very different from the consensus, which is people expecting two to three hikes this year and 75 to 100 basis points next year.”
“That could happen, but I would be surprised if we don’t see an impact on domestic and consumer economic activity after two or three rate cuts.”
Beagles added that Brits are reportedly sitting on a surplus of £280 billion to £300 billion in savings, so the UK domestic market (and high street) would benefit from higher consumer confidence. As a result, consumer stocks from Currys (CURY) to sofa maker DFS (DFS) could see a return to sales not seen since 2019, and their price-to-earnings multiples rise accordingly.
Labour Government: Ready for big spending?
In the interim, a new government might also help: “The market is ready for that,” Beagles said.
“The most interesting thing is the debate about whether a very large majority is a good thing or a bad thing. There are a variety of opinions from a market perspective.”
“The majority of people [Labour] It could become more radical, or Starmer could ignore the left wing of his party and become more centrist.”
Anyone thinking of continuing to trade during the election period might want to think twice. That said, there is a real connection between markets and the real economy. The UK’s infrastructure problems are the biggest challenge for the next Labour government. Companies that solve these problems, if solved, would really stand to benefit.
“When you consider the money that would need to be spent on prisons, schools, hospitals and low-carbon transport, the total figure runs into hundreds of billions of pounds,” Mr Beagles said.
“But a lot of stocks in the supply chain are trading at very low multiples. These stocks will naturally benefit.”
“It’s hard to imagine Labor will neglect these parts of the market – if anything, more money will be put into them.”