UK Stock Market Outlook: Prepare for An Exciting Q3

Election day is approaching, but so are real challenges and opportunities for UK PLC

Christopher Johnson 1 July, 2024 | 9:05AM
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UK Bull Market Main

As Thursday's election nears, a tapestry of different narratives is setting the UK's equity markets up for a very eventful second half of the year.

The UK's story has felt more complex and contradictory than in the US, where the continued dominance of the "Magnificent Seven", especially Nvidia, has made the first half of 2024 all about tech.

Politics and Growth Key to Stock Market Outlook

Here in the UK, gross domestic product (GDP) stagnated but equities hit record highs and serious talk of initial public offerings (IPOs) and M&A emerged once more. Again, there's been a disconnect between the real economy and the stock market.

A number of UK companies from different sectors emerged as bid targets: food delivery firm Deliveroo (ROO), mining giant Anglo American (AAL), and, in financial services, Hargreaves Lansdown (HL.).

The political noise has been hard to ignore as the half-year period ends, with the polls predicting a Labour landslide on July 4. There is also a buzz around the Bank of England's hotly-anticipated first rate cut, which is likely to come on August 1. 

Abby Glennie, deputy head of smaller companies at Abrdn, and lead manager of the Morningstar Silver-rated Abrdn UK Mid-Cap Equity fund and co-manager of Abrdn UK Smaller Companies fund, has previously told Morningstar the FTSE's gains in the first half of the year are largely attributable to the UK regaining favour with foreign investors. The GDP reading for the first quarter of the year has just been upgraded to 0.7% and the IMF is forecasting growth double that in 2025.

Over the past six months, the FTSE 100 has increased 6% to 8,189 points on the last trading day of the quarter, a trend driven principally by anticipation of a stronger economy and the end of an extensive mergers and acquisition drought. The Morningstar UK index is up more than 7% in the period.

"One of the negatives the UK has found in recent years is that it has not had the big artificial intelligence (AI) exposure the US market has," Glennie says.

"But we are now in a good point in the cycle whereby a decent chunk of industrial and domestic cyclicals are now lifting the UK market."

Which UK Stocks Did Best in The First Half of 2024?

Narrow-moat aerospace and defence company Rolls-Royce Holdings (RR) led the pack of FTSE 100 stocks with the best performance over the six months to June 21 2024.

The stock returned 57.9% during that time, hitting a record share price of £4.76 and outpacing Morningstar's Fair Value Estimate, which remains at £3.80. The business, which produces many of the world's jet engines, had benefited from the surge in international travel since the pandemic, but rising geopolitical tensions have helped the defence division.

NATO members continue to promise bigger military budgets due to counter Russia's threat –a development analysts predict will only boost British defence companies like Rolls Royce and BAE Systems (BA.).

The financial services sector did well too. Hargreaves Lansdown (HL), Natwest Group (NWG), Barclays (BARC), Intermediate Capital Group (ICG) and Beazley (BEZ), all made our top 10 list of stocks for year-to-date returns. 

Having enjoyed an initial share surge in May after news of a potential buyer hit the headlines, Bristol broker and fund supermarket business Hargreaves Lansdown continued to enjoy a share price boost.

The finalities of a private equity consortium deal that would delist it from the FTSE 100 are yet to be revealed, but the event has provided a silver lining to the company's otherwise lacklustre share price performance since 2019, when the Neil Woodford scandal broke.

ICG, meanwhile, has reported higher pre-tax profits, while banking stalwarts Natwest and Barclays benefited from a rise in retail deposits and interest rates remaining "higher for longer".

Which Stocks Suffered in The First Half of 2024?

At the other end of the performance spectrum, the UK's consumer cyclical stocks struggled in the wake of continued cost of living concerns.

Entain (ENT), Burberry Group (BRBY), JD Sports Fashion (JD) and Whitbread (WTB) were among the shares with the poorest returns on the FTSE 100, losing 32.4%, 30.4%, 23.7% and 17.6%, respectively. As public belts tightened due to high inflation, non-essential spending took a hit, as did the companies themselves.

But they weren't the worst affected.

According to Morningstar data, Ocado Group (OCDO) was the worst-performing stock in the FTSE 100 in the first half of the year, reporting a share price fall of -58.9%.  

Its underperformance resulted in demotion from the FTSE 100, and can be blamed on heightened competition in the UK's already-competitive grocery market, as well as the cost of living crisis itself.

Whose UK Dividends Look Strongest?

It was a strong first half of the year for dividends. In our latest round-up of top FTSE 100 dividend-paying stocks, we highlighted four companies whose dividends are set to increase: including Imperial Brands (IMB), BT (BT.A), HSBC (HSBA), and AstraZeneca (AZN).

Of these, AstraZeneca's latest £2.47 per share dividend will be its highest in five years, and a 7% hike on the dividend it paid in 2023. In 2021 it paid £2.02. Imperial Brands (IMB) and BT (BT.A) are also both expected to pay £2.24 and 56p per share in September, respectively, an increase on the dividends they paid out in Q3 2023, when they paid £2.16 and 54p, also respectively.

"The dividend picture for UK equities looks in reasonable health," says Mark Preskett, senior portfolio manager at Morningstar Wealth.

"Of the largest 50 companies by market capitalisation listed on the [FTSE 100], just six firms have distributed a lower dividend in the first five months of 2024 compared to the same period in 2023.

"The average increase is around the 9% mark, so a mid-to-high single digit dividend growth from the FTSE over the course of 2024 is not an unreasonable expectation. This is a far rosier picture than during the depths of Covid, when UK equity dividends fell 40% year-on-year."

Away from dividends, UK companies have continued to buy back their own shares, a practice that is the subject of much debate. Buybacks mean companies can distribute income to shareholders without being bound by dividend commitments, and increase earnings per share to boot.

But repurchase also begs other questions: are companies buying back their own stock at a good price? And, crucially, does the money allotted by companies for the repurchase of shares starve other projects of vital capital expenditure?

"The increase in UK buybacks has been very pronounced," observes Preskett.

"In 2023, 12% of UK large firms bought back at least 5% of their shares, which compares favourably with 9% of US companies."

Which UK Companies Are Takeover Targets?

The bid for Hargreaves Landsdown is one example of mergers and acquisitions activity returning to life.

"We have seen a sharp spike in UK M&A in 2024, another signal that the UK is undervalued," Preskett says.

"According to the Office for National Statistics, Q1 2024 M&A disposals involving UK companies was more than £10 billion, which is the second highest quarter since 2000. We've seen more activity in Q2, not least the giant PE-backed bid for Hargreaves Lansdown."

Richard Marwood, portfolio manager of the Morningstar Gold-tated Royal London UK Equity Income Fund, told Morningstar UK M&A is now affecting big companies once more.

"It has either been the companies themselves buying back their own shares – that has been a dynamic. But then its also M&A activity," he says.

"It started at the smaller end of the market but in 2024 we have seen it go further up the capitalisation spectrum."

The potential targets of this activity (and their bidders) are listed in the table below.

London-based mining major Anglo-American (AAL) was recently targeted by BHP Group (BHP) in a takeover bid it later rejected, while paper packaging brand DS Smith (SMDS) also agreed to a £5.8 billion takeover deal by its larger US rival International Paper (IP).

But though it's exciting – and arguably lucrative for shareholders who find themselves in the right place at the right time – it is not necessarily good news.

"The real issue is around how takeovers and buybacks shrink the market," says Marwood.

"There is a little bit more evidence of existing companies raising a bit more equity. But overall, the dynamic is that the UK equity market is shrinking."

All that means new players are needed more than ever to bolster the ranks. In this sense, the announcement that Chinese fast fashion giant Shein might list in London (bringing a $60 billion-plus stock to the FTSE 100) could be a promising development.

Raspberry Pi (RPI), the Cambridge-based computer company that listed on the FTSE 250 index with a £542 million valuation in June, is a smaller addition to UK public markets, but its IPO did at least add to the narrative that UK flotations had not ground to a halt. The stock even bounced on the first day of trading. Investors can only hope neither company ends up in the same position as Deliveroo: publicly-listed, performing badly, and the subject of takeover bids.

Other takeovers are worth noting too. Carlsberg (CABGY) is bidding for UK soft drink maker Britvic (BVIC), though its initial approach was rejected on valuation grounds.

When Will The Bank of England Cut Rates?

Much hinges on what the Bank of England does next. Though higher interest rates have benefited retail banks, the high cost of borrowing has made life more challenging for companies and their consumers alike.

At the end of last year, plenty of analysts were willing to boldly predict several rate cuts in 2024, and yet there has not been a single one. It is, as they say, though, a matter of time.

Clive Beagles, portfolio manager of the Morningstar Gold-Rated JOHCM UK Equity Income fund, says he was surprised the Bank of England did not cut rates in late June. That said, he now thinks fewer cuts will be needed anyway due to more favourable economic conditions.

"We might get two or three [cuts] and that might be it," he says.

"That would be very different to the consensus. People have bet on two or three this year and then another between 75 to 100 basis points next year in mind.

"That could happen but we would be surprised if, after two or three rate cuts, we do not see an impact in terms of activity from the domestic side and the consumer facing side of the economy."

Beagles adds that the British public is reportedly sitting on around £280 billion to £300 billion in of excess savings, priming the UK domestic market (and the high street) to benefit once consumer confidence increases. As such, consumer stocks ranging from Curry's (CURY) to sofa manufacturer DFS (DFS) may recover sales volumes not seen since 2019 – with an accompanying rise in prices to earnings ratios.

Labour Government: Ready to Spend Big?

Tentatively, a new government might also help: "the market is ready for it," says Beagles.

"What’s most interesting is the debate about whether a very large majority is a good or a bad thing – from a market point of view there are different opinions.

"A large majority could allow [Labour] to be more radical, or it could allow Starmer to ignore the left-wing fringe of his party and be more centrist."

Anyone looking to trade their way through the election might want to think twice. That said, there are real connections between the markets and the real economy. Britain's infrastructure woes are the top the agenda for the prospective Labour government. If dealt with, the companies that solve those problems could really stand to benefit.

"When you think about the money we need to spend on prisons, schools, hospitals, and low carbon transport, that all adds up to hundreds of billions of pounds," Beagles says.

"And yet many of the stocks that are in the supply chain are trading on very low multiples. These stocks will be natural beneficiaries.

"It is hard to see the Labour party deemphasising those parts of the market. If anything, we will see greater money being put to work there."

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
abrdn UK Mid-Cap Equity I Acc202.95 GBP1.22Rating
abrdn UK Smaller Companies Inst S Acc113.22 GBP1.18Rating
Anglo American PLC31.30 USD4.55
AstraZeneca PLC12,190.00 GBX-0.57Rating
Barclays PLC223.00 GBX0.25Rating
BHP Group Ltd2,250.00 GBX-1.66Rating
Britvic PLC1,261.34 GBX-0.05
BT Group PLC138.85 GBX-1.66Rating
Burberry Group PLC11.65 USD2.19
Carlsberg A/S ADR25.17 USD-1.22Rating
DS Smith PLC421.00 GBX0.05
Entain PLC8.81 USD4.23
Hargreaves Lansdown PLC1,100.50 GBX-0.32
Imperial Brands PLC2,067.65 GBX-0.83Rating
International Paper Co43.63 USD1.68Rating
JD Sports Fashion PLC1.53 USD-6.75
JOHCM UK Equity Income Y GBP Inc1.41 GBP0.72Rating
NatWest Group PLC321.90 GBX-0.53Rating
Ocado Group PLC331.59 GBX-12.74Rating
Rolls-Royce Holdings PLC450.20 GBX0.04Rating
Royal London UK Equity Income M Acc285.51 GBP0.67Rating
Whitbread PLC2,923.00 GBX-0.34

About Author

Christopher Johnson  is data journalist at Morningstar

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