The UK equity market remains relatively cheaply valued with a forward price-earning multiple (PE) that is around 25 per cent below long-term averages and close to 50 per cent cheaper than the US. In a recently published report, “Equities 2023: Market uncertainty to remain amid tighter policy”, Fidelity International expects a high degree of volatility and uncertainty for global equities in 2023, as stubbornly high inflation and interest rate rises lead to a rough landing for large parts of the global economy. However, earnings expectations are diverging across different economies, allowing investors to capitalise on select opportunities.
After the sharp sell-off spurred by the worsening outlook and government missteps, there is a case for the UK equity market to become an attractive hunting ground in 2023. While the UK market has done better than most this year, partly due to sector composition (with most large-cap earnings derived from outside the UK), it remains relatively cheaply valued with a forward PE that is around 25 per cent below long-term averages and close to 50 per cent cheaper than the US.
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The large-cap FTSE 100 index remains primarily a play on the global economy and a beneficiary of sterling weakness, while small and mid-cap names tend to be more exposed to the domestic economy. The latter are unloved and could be beneficiaries of any positive surprise on the economic front.
The US presents a different picture. While there are some signs of increasing pressure on consumers, real data has yet to turn downwards, and markets are some way off pricing in the sort of corporate earnings downgrades that would reflect a full-blown recession. That leaves us with the risk of a more dramatic drop in the S&P 500 next year if growth slows suddenly.
Nevertheless, small/mid-cap stocks appear cheap relative to large caps, which should present some opportunities. Meanwhile, growth stocks still look relatively expensive versus value stocks, with the valuation gap at historic highs.
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Another potential risk for investors is further US dollar appreciation, which would continue to erode corporate earnings. The S&P 500’s foreign exposure is around 30 per cent. Emerging markets have historically been especially sensitive to changes in the greenback’s value and US companies are not immune to these headwinds as their offshore revenues begin to shrink.