The UK Budget brought renewed optimism that a combination of the British ISA and pension reforms could galvanise investment in UK companies, reversing the £50bn or more in outflows from UK stockmarkets since 2016. There has also been growing confidence that global investors might look beyond a handful of US technology companies, paying closer attention to other sectors and regions.
However, the latest set of IA data suggests that – for UK retail investors at least – this isn’t happening at all. If anything, the opposite is happening. In January, outflows from the UK market were £1bn, higher than for the previous two months. For 2023 as a whole, outflows were £13.6bn, its highest level since 2016 – and part of a pattern of gradually increasing outflows over the past five years.
In contrast, despite the talk of the US market being highly valued, and investors tiring of the Magnificent Seven trade, flows into the US remained robust – £625m for the last quarter of 2023 and another £63m in January. It was a similar picture for the other 2023 success story Japan, with flows of £448n in the final quarter and another £22m in January. Only Europe, and to a lesser extent, Asia, showed any signs of a recovery. By January, outflows from European funds had dwindled to £20m, and in Asia to £43m (and would have been flat if China were excluded).
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This pattern is supported by a range of other flow and sentiment reports. For example, the most recent Bank of America Fund Manager Survey showed that allocation to technology is now at its highest level since August 2020, and exposure to US equities more broadly has also risen. Small-cap stocks remained unpopular, with 41% of survey respondents saying they expected large cap stocks to drive equity markets, versus 18% for small caps.
Perhaps more importantly, it also showed that on a regional basis, fund managers continued to shift money away from UK and emerging markets, towards US, Eurozone and Japanese stocks. It found that the most crowded trades were to be long the Magnificent Seven (61%), and to a lesser extent Japanese equities, and then short China equities (25%).
The Calastone fund flow index showed that February 2024 was the best month since May 2021 for equity fund inflows and the fourth best on record. However, it found that flows were highly concentrated, with the majority going towards North American funds (£2.5bn). It supported the IA data in showing some resurgence in European equities, which saw £363m in inflows. Unfortunately, it also supported the view that everyone hates the UK. The UK saw £633m in outflows.
For the brave contrarian, this might represent a capitulation point on UK equities and the peak for US equities. Perhaps it is darkest just before the dawn? Bank of America strategist Michael Hartnett says that “overly bullish investor positioning was increasingly becoming a contrarian headwind for risk assets”, suggesting he believes tougher times are ahead for the pro-US trade.
John Roe, head of multi-asset funds believes a tipping point may be edging closer: “We are looking for assets where the upside and downside feel asymmetric. The US has the lowest level of unemployment since 1960. Despite that, it has a 7.5% fiscal deficit. Traditional economics would say, save in the good times to help in the bad times, but that’s gone out the window. It is hard to get an improvement in the economy because of falling unemployment because it is already so low, or because of government spending, because it’s so high. That makes us a bit more cautious on our thinking because there is so much positivity built in.”
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On the UK, there are reasons stocks could turn. Matt Tonge, fund manager on the Economic Advantage team at Liontrust, points to the level of M&A activity: “49 companies were taken out between November and January.” He says there is also policy intervention and the British ISA may bring momentum. “The government is thinking about the connection between the UK economy and the stockmarket. This may turn around the doom loop and could prompt a sentiment shift from an international perspective.” The high level of buybacks is also changing the landscape for the UK.
Turnarounds can happen quickly, and without warning. Japanese funds suffered their highest redemptions in a decade in 2022, with UK retail investors pulling £1.16bn. It left stocks looking extremely cheap, galvanised policymakers and the rest is history – the Nikkei saw its strongest performance in a decade in 2023. Will Lough, manager on the R&M Global Sustainable Opportunities fund, says: “There wasn’t really a top level catalyst for Japan. Companies just delivered quite good earnings and had low valuations.”
Ben Arnold, investment director on the Schroders Value team agrees that catalysts may be seen more in hindsight: “People ask ‘what is the catalyst?’, but as we see it, if you can see the catalyst, the shares won’t be that cheap.” The value team at Schroders is running as high a weight in small and mid-cap companies as it has ever done, for example, and he adds: “It’s enough to know that over the long term, they typically outperform. But we don’t know when they’ll outperform.”
Investors waiting for the markets to turn away from the expensive US and towards unloved areas, particularly the UK, will need to be patient. Lough believes more than ever, this will prove an important quality: “Investors need to work out what something is really worth.”
For the UK, buybacks and M&A can fill a gap, but they can only go so far without a turnaround in sentiment. Elsewhere, there are hints at a change of regime, as Tesla falls out of the top ten of US largest companies, but investors have shown no signs of breaking their broader entanglement with the US market. It is possible to make a case for both the revival of the UK, and the weakening of the US, but it isn’t happening yet.
This article was written for our sister title Portfolio Adviser
