The outlook for UK equities in 2023

Our award-winning managers look back on 2022 and share their investment insights for the year ahead

Richard Hallett, head of our UK equities investment team, provides an overview on the outlook for UK equities.

In 2022 we experienced a very complex year and one unlike any I have seen in more than 25 years as a fund manager. Stock markets pulled back significantly as sharp increases in interest rates fuelled concerns about slowing global economic growth.

What has been particularly challenging about the market downturn is that it has been precipitated by central bankers, who have increased rates to tame a spike in inflation triggered by the lifting of pandemic lockdowns and accelerated by Russia’s invasion of Ukraine.

In the Great Financial Crisis and when the dot-com bubble burst, central bankers stepped in to cut rates and stimulate growth. But this time the reverse has happened.  

Looking ahead, we expect the slowdown in global economic growth to continue. We anticipate a shallow recession in the US, due to its robust economy, and a more pronounced slowdown in the UK and Europe, partly because of issues around energy supply.

We expect inflation to fall in 2023, but not to the very low levels we have been accustomed to in recent years. There are several reasons for this: the cost of the transition to green energy, the continuing conflict in Ukraine and the challenge of companies moving their manufacturing out of China.

In a higher-inflation environment, the ability to pass on rising costs to customers through ‘pricing power’ will be essential for companies seeking to protect their margins.

More generally, UK equities look significantly undervalued compared to other developed markets and we do not expect this to last indefinitely. The value available in the UK market was demonstrated by a succession of acquisitions by companies and private equity houses in the first half of 2022. We expect this M&A activity to gather momentum again.

It is also worth remembering the nature of markets, which are forward-looking. Inflation appears to have peaked in the US and Europe, which is likely to lead to an easing in the pace of interest rate rises, which should be positively received. Investors will also, at some stage, begin to look beyond the slowdown, with sentiment improving as they begin to position themselves for a more positive economic climate.

Sector outlooks

UK All Companies

Richard Hallett, Manager of Marlborough Multi-Cap Growth

Despite the challenging backdrop, the vast majority of the companies in our portfolio are continuing to trade well. This should be no surprise as we have sought out businesses that are benefiting from long-term structural trends and can continue to grow without relying on a positive economic backdrop. These are exceptional companies with sustainable competitive advantages, robust balance sheets and resilient earnings.

In an uncertain environment, we believe these characteristics will prove increasingly attractive for investors. While quality growth businesses have been very much out of favour during the past year, we believe we are entering a new period where fundamentals and potential earnings growth will once more be key factors in determining valuations.

Using our stringent investment criteria, we have constructed a portfolio of just over 40 high-quality companies, the majority of which are focused on global markets. These are businesses with strong growth prospects and we believe they will emerge from the slowdown stronger than ever. The sell-off has enabled us to add to many of our investments at valuations significantly lower than a year ago and we believe this has created an exceptional long-term opportunity.

UK Equity Income

Sid Chand Lall, Manager of Marlborough Multi Cap Income

After the challenges of 2022, we believe the outlook for high-quality dividend-paying companies is now significantly more positive. The indiscriminate nature of the stock market sell-off has left many businesses, particularly smaller companies, looking substantially undervalued.

We have seen companies that were on P/E multiples of 20x derated to 10x. These are well-managed businesses that have strong long-term prospects and are paying attractive and often growing dividends.

We have a bias to small and mid-cap companies and this area of the market has been particularly out of favour. However, we have not been tempted to change our strategy. Experience has taught us the importance of sticking to our well-established investment process. This has enabled us to bounce back strongly from previous sell-offs, while also paying a higher dividend yield than the FTSE All-Share in every year since launch.

The vast majority of the companies in our portfolio continue to trade well. They have high-calibre management; pricing power, so they can pass on rising costs; and robust order books, providing good earnings visibility.

We believe investing in these companies at current valuations presents an exceptional opportunity over the medium to long-term. Their growth prospects will not be overlooked forever and we believe there is scope for significant upside. In the meantime, the dividend income from these companies means that we are being well paid to wait.

UK Smaller Companies

Eustace Santa Barbara, Co-Manager of Marlborough Special Situations, Marlborough UK Micro-Cap Growth and Marlborough Nano-Cap Growth

We believe the outlook for smaller companies is exceptionally attractive over the medium to long-term.

In the short term, uncertainty continues. The full effects of interest rate rises typically take nine to 12 months to be felt in the economy and depending on the depth and duration of the UK recession estimates for earnings per share may need to be revised.

However, taking a longer-term view, we are seeing valuations of small and mid-cap companies that are genuinely exciting. Businesses with excellent long-term prospects are on P/E ratings that are at multi-year lows. Some companies are on their lowest P/E multiple for a decade.

In many cases these are innovative businesses led by high-calibre management teams ready to move with agility to seize new opportunities. These companies are often operating in lucrative niche markets with global customer bases and the potential for rapid growth.

It is often the case that looking where others are not can bring handsome rewards. While smaller companies are currently out of favour with investors, historically they have significantly outperformed their larger counterparts.

The sell-off means businesses with market-leading products, strong balance sheets and outstanding growth prospects are now on substantially reduced valuations. For investors taking a longer-term view, we believe this presents a rare opportunity.

Risk Warnings

Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds. Our funds invest for the long-term and may not be appropriate for investors who plan to take money out within five years. The funds will be exposed to stock markets and market conditions can change rapidly. Prices can move irrationally and be affected unpredictably by diverse factors, including political and economic events. The funds invest in smaller companies which are typically riskier than larger, more established companies. Difficulty in trading may arise, resulting in a negative impact on your investment. The funds invest mainly in the UK therefore investments will be vulnerable to sentiment in that market which may strongly affect the value of the funds. In certain market conditions some assets may be less predictable than usual. This may make it harder to sell at a desired price and/or in a timely manner. On Marlborough Multi Cap Income, all or part of the fees and expenses may be charged to the capital of the fund rather than being deducted from income. Future capital growth may be constrained as a result of this. Dividends paid by companies are not guaranteed and can be cancelled, which may impact the fund’s ability to deliver an income to investors.

Regulatory Information

This material is for distribution to professional clients only and should not be distributed to or relied upon by any other persons. It’s provided for general information purposes only and is not personal advice to anyone to invest in any fund or product. Information taken from trade and other sources is believed to be reliable, although we don’t represent this as accurate or complete and it shouldn’t be relied upon as such. Calls will be recorded for training and monitoring purposes.

Issued by Marlborough Investment Management Limited, authorised and regulated by the Financial Conduct Authority (reference number 115231). Registered office: PO BOX 1852 Lichfield, Staffordshire, England, WS13 8XU. Registered in England No. 01947598. Investment Fund Services Limited (IFSL) is the Authorised Corporate Director of the Fund. IFSL is registered in England No. 06110770 and is authorised and regulated by the Financial Conduct Authority. Registered office: Marlborough House, 59 Chorley New Road, Bolton, BL1 4QP. Copies of the Prospectus and Key Investor Information Documents are available from www.ifslfunds.com or can be requested as a paper copy by calling 0808 178 9321 or writing to IFSL at the registered office above.