Market Update 17th March 2025

Conquer your fate

A lot has happened over the last few weeks. The consensus view appears to be that the market is concerned about possibly weakening growth in the US. There has also been a change in rhetoric from the government. Treasury Secretary Scott Bessent has made various comments about for example a “detox” period for the market being a good thing. As Emily wrote last week: at the stock level, higher expectations lead to a lower margin of error.

This also applies at the country level. Many of the countries with the largest recent sell-offs started on the highest valuations – most obviously the US which has been in the 99^th percentile of its historic valuation (in other words almost as expensive as it has ever been). American exceptionalism has become everyone’s specialist subject of the moment.

As I write the S&P 500 is on 20.8x forward earnings, having fallen 5.9% YTD and just over 10% from its 19^th February peak. This is still 30% above its 20 year average of 16x. Earnings estimates for 2025 have fallen slightly from 14% in September 2024 down to 12% now, but estimates for 2026 and 2027 have continued to rise. Expectations and valuations are still high.

The UK is on 11.9x forward earnings despite being up 5.5% YTD. There was even some negative growth news out on Friday with UK GDP down -0.1% in January, following +0.4% in December and +0.1% forecast. Even so, the market is up slightly on the day. Expectations are different here. Keir Starmer isn’t running the country on social media.

As ever with our Market Updates, I feel I need to set the scene, but don’t want to get too caught up in the nuts and bolts which are available elsewhere.

We have been overweight in the UK and underweight in the US for some time on valuation grounds and while we have been able to offset some of this with positive performance elsewhere, it has still been painful.

But whatever the rationalisations might or might not be for the recent market moves, what I find notable is how quickly they have come.

In 2024, the UK returned 9.5% which would usually be a good year, except the US returned 27.3% in sterling – 17.8% outperformance. But if we roll forward to today and look at the twelve months to mid-March, the UK is now outperforming the US by nearly 3%.

The UK hasn’t moved much – the 12 month return is now 10%, but the US has collapsed to just over 7% – though as with the UK last year, this would be no disaster in more normal times. It’s not predictive, but I have a chart that shows the US has historically not made up this kind of first quarter underperformance in the calendar year.

Everything isn’t suddenly okay. UK small caps are down -4.5% year to date. Some of our renewable infrastructure holdings remain stubbornly unloved, like a recalcitrant cat.

Is it going to last?

Many people have spent the last few years asking about “catalysts”, but I think this is simplistic and over-rated. The market doesn’t leave simple signposts like this in my experience.

The UK market is cheap but has been seemingly overlooked. Outflows have continued, and pension fund weightings are drastically down. Everyone knows this.

The reversal of these UK fund outflows is high on the list of potential catalysts that the market has been waiting for. But those outflows didn’t stop good absolute performance last year. There have been large outflows in January and February this year as well – and the market has continued to perform. Waiting for positive inflows as a sign that the rest of the market agrees with us on the UK wouldn’t have helped us.

The market has also been looking for changes in the UK. Abolish stamp duty on share purchases, something about UK ISAs. No doubt these are good ideas, but a number of changes have already been made.

Some of this may sound a little technical, but there have been a number of UK listing rule changes, measures to be more inclusive of retail investors, changes in pension investment rules and a change in emphasis on FCA regulation – all designed to reduce friction and increase investment in the UK equity market.

We might succeed with all this, or we might not. But setting aside what I think was a mistake in changing the tax rules on AIM, the government is already taking tangible steps to intervene more positively and lift the UK market. It is still cheap relative to its history, small and mid-caps are still lagging vs their historical performance.

I don’t know if this is a short-term blip or the start of a long-term trend, but I do believe we have a solid foundation and framework through which to look at it. Valuation is a poor short-term indicator, but a good long-term one. It’s not about knowing the future. It is about analysing and evidencing what you do know, and building around that.

Robert Fullerton – Senior Research Analyst

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