UK Stocks Are Cheap. The Problem Is Everything Else.

Energy, rates and policy are a mess. But when things are priced for failure, you don’t need success. Just less bad.

At the beginning of the year, one of my proclamations was that UK stocks were looking decidedly cheap.

That view hasn’t changed.

Yes, the country is a mess on numerous levels. But so was Japan in 2015, and its stock market went on to perform very well off the back of depressed valuations. There are parallels.

I said I would cover UK opportunities, and I will. There are plenty. But I tend only to write about what I am actually investing in. It keeps incentives aligned. And here’s the problem.

I haven’t quite been able to bring myself to pull the trigger.

The reasons are obvious.

First, the decision by a certain homme orange to bomb Iran. We are seeing the opposite of “Drain the swamp” and “I’m not going to start wars, I’m going to stop wars”. There is no clear victory in sight and we do not yet know what all the repercussions will be, except that there will be lots of them.

Second, the resulting rise in the cost of energy. Economies need a base of abundant, cheap energy on which to grow. What they do not need is constrained, expensive supply, and that is the reality the UK now faces, a mess largely of its own political and ideological making.

High energy tighten financial conditions. They squeeze margins, lower disposable income and reduce activity. Economies need the opposite.

And that brings me to item three on the agenda: the cost of capital. Borrowing costs have risen again across the board. For the government: ten-year gilts are around 5%, the highest since 2008 and above the Truss spike. The UK has the highest borrowing costs in the G7. Aren’t you proud?

Mortgage rates have also risen, with most fixed rates now above 5%. This means remortgaging pain for hundreds of thousands of households, as exisiting deals expire.

Headline inflation is now above 3% and the Bank of England Governor Bailey has said further rate cuts are “not on the horizon.”

The knock-on effects are visible everywhere. Company insolvencies are at 30-year highs. We are teetering on the brink of a house price crash - it’s already here if new build is your thing.

And here’s another telling indicator: car production has collapsed from 1.7 million units in 2016 to around 700,000. Demand, both from abroad and at home, is weak.

Fourthly, there is my macro call that in quarters 2 and 3 of this year, if markets are going anywhere, it’s sideways or down, as per the typical second year of a presidency. Things won’t get moving till Q4.

I also like to have cash available for the kind of sharp sell-offs that appear from time to time. We seem to be on the cusp of one but it hasn’t quite materialised.

So the situation is this: UK equities are cheap. Very cheap in places. But the broader investment landscape has deteriorated.

Yet valuation is everything. When things are priced for bad outcomes, you do not need perfection. You just need things to stop getting worse.

There are pockets of the UK market trading on deeply depressed assumptions. Entire sectors where sentiment has overshot reality. If the macro stabilises even slightly, the upside could be significant.

So here is what I am looking at.

Some of these are obvious. Some are not.