Client Update - 17th January 2025

There has been growing commentary around the US big-cap stocks’ valuation premium over UK stocks that has risen to record levels since 2021. The interesting question is where UK listed companies derive significant profits from their US enterprises, does this offer a compelling value opportunity to buy US exposure via the discounted UK asset?

Estimates for the next two years, for revenue and earnings per share growth for the US, are about twice as high as the growth estimates for the UK. Now, estimates for the US might be too euphoric (AI and all that), and those for the UK might be too pessimistic. More importantly, stock markets are not meant to discount the growth rate for the next two years; they are meant to discount all future cash flows, forever and ever. Is the US’s current above-trend growth and the UK’s sluggishness a permanent condition? Time will tell but it is unlikely.

I wrote last week about the turmoil in the UK debt market, as Gilts were under significant price pressure as yields rose, as the UK’s outlook started 2025 in rather poor shape. Better news arrived this week, with UK inflation unexpectedly slowing to 2.5 per cent in December. This news was welcomed by chancellor Rachel Reeves and probably cleared the path for the Bank of England to press ahead with cutting interest rates next month. The consumer price inflation figure, which was below November’s 2.6 per cent reading, triggered the biggest one-day rally in gilts in more than a year as analysts had expected inflation to hold steady last month.

Currently economists still expect inflation to reaccelerate in the months ahead, particularly given that December’s drop was driven by volatile factors such as lower airfares. The recent increase in UK government borrowing costs, which last week hit a 16-year high, has threatened to blow a hole in the chancellor’s promise to balance day-to-day spending with tax receipts by 2029. Wednesday’s UK inflation data was also strengthened by a lower than expected US core inflation the same day. The yield on 10-year gilts fell 0.16 percentage points to 4.73 per cent, their best day since late 2023. The pound rose 0.1 per cent on the day to $1.222. Jumping on the good news, Prime Minister Sir Keir Starmer immediately said Reeves would remain chancellor for “many years” and that Labour this year would hold only one Budget, which is when the UK government typically announces tax changes.

The Bank of England’s (BoE) Monetary Policy Committee is indeed preparing to hold its first meeting of 2025 next month and following the data, traders were pricing in a more than 80 per cent chance of a quarter-point cut in February, compared with about 60 per cent beforehand. Wednesday’s data showed that services inflation, which is closely watched by the BoE as a gauge of underlying price pressures, slowed sharply to 4.4 per cent from 5 per cent previously. It was also below the 4.9 per cent reading expected by economists.

About half of the drop in services inflation was driven by airfares, according to Capital Economics. Airfares growth was the third-weakest for a December on record. This was partly because the Office of National Statistics collected airfare data around December 10, before the usual boost to prices driven by the school holidays, and looked at flights returning on Christmas Eve and New Year's Eve, which tend to be cheaper than the surrounding days. Core inflation, which excludes food and energy, dropped to 3.2 per cent from 3.5 per cent.

It is good to be focussing on UK assets after many years of US focus. I am sure the return of Trump next week will generate plenty of headlines, but for now we see green shoots of opportunity back home that the investment team are carefully taking advantage of. Do have a good weekend.