The UK reclaiming its place as Europe’s largest equity market was rather overshadowed this week by news that a certain US company (no prizes for guessing which) has become the world’s most valuable. That’s par for the course given the pull that New York, and Silicon Valley, exert on investors in the modern age. But it shouldn’t cloud our judgement entirely.
Most of the Magnificent Seven may be soaring, but it remains an under-recognised fact that much of the US market has behaved as you’d expect at a time of higher interest rates. We noted last year that the more defensive FTSE 100 had outperformed the S&P 500 since the western world’s rate-hiking cycle began in December 2021. That remains the case as of this summer – irrespective of whether you convert US returns to sterling or not.
Indeed, of the major investment regions (encompassing individual developed markets, and a representative collective benchmark for emerging markets), only Japan can boast a better stock market than the UK in local currency terms over this period. And given the weakness in the yen during this time, only domestic Japanese investors will have been able to enjoy this comparative advantage.
Yet the UK’s surfeit of dividend payers means a large portion of the return that contributed to the above statistic isn’t visible to those checking price graphs online. As our columnist Robin Hardy pointed out earlier this year, more than half of the 8.6 per cent annualised return made by the FTSE All-Share over the past four decades has come from dividends. By definition, then, looking at capital growth alone doesn’t give even half the picture.
There’s no denying the large-cap index has its fair share of sclerotic companies, just as critics suggest. However lowly valued their shares may be, these companies are not going to revive en masse, absent the odd boost that arrives every time interest rate cuts appear on the horizon. Those buying bombed-out telecom giants, for instance, have had very different experiences so far this year. BT’s spring share price gains, derived the fact that cash flow improvements are finally in sight, have continued in recent weeks. Yet Vodafone has gone back into reverse, notwithstanding its own turnaround attempts.
This isn’t necessarily a problem. In investing, as elsewhere, the number of parts that must flourish for the whole to prosper is lower than you may think. As the economist Hendrik Bessembinder and others have pointed out, most shares underperform the market, and overall returns are driven by a select group of stocks.
For those who see down days on the FTSE and grind their teeth, it’s worth noting that the market as a whole is also remarkably inconsistent: Bespoke Investment analysts pointed out earlier this month that the historical odds of even US shares being up on any one particular day stand at just 53 per cent.
Coincidentally, the Bespoke team observes, this is roughly the same point win percentage sustained by elite tennis players. In tennis, this is a question of fine margins. In investment, it comes down to compounding. The latter, for all its merits, is not an easily observable phenomenon in the short-term. It’s only over the long term that the impact of a gradual move higher in prices can be observed.
Admittedly, there are counterarguments at hand here, too. Change the time horizon to a longer period and the FTSE All-Share has clearly underperformed many international peers. The point is that any renewed upturn in fortunes for the domestic market could well arrive not with a bang but with something more like a whimper. It’s in this context that the pullback from last month’s record highs should be viewed. The market doesn’t go up in a straight line: for all but the most runaway indices, success is something that emerges in fits and starts, in pockets rather than all at once. Structural flaws and political instability may have dogged the UK market in recent years, but don’t underestimate its ability to keep grinding higher.