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Sometimes you don’t appreciate what you have got until it is gone. How soon before Britons wake up to the national disaster that is unfolding in the stock market? Around the world, stock market indices are being drive to new highs by what the Financial Times recently described as a global investor “risk reset” reflecting growing confidence in the global recovery. Yet there is one glaring exception to this trend. Since the beginning of January, the S&P500 index of US shares is up 9.8 per cent, the Dax 40 and CAC40 indices of German and French shares are up 9.0 per cent and 7.6 per cent respectively, and the Nikkei 225 index of Japanese shares is up a remarkable 18.2 per cent. The exception is Britain, where the FTSE 100 is up just 2.4 per cent.
Nor is this a recent phenomenon. UK stocks have been dramatically underperforming the rest of the world since the Brexit referendum. If you had invested £100 in the FTSE100 in June 2016, your investment would now be worth £118. If you had invested the same sum in the CAC40, it would be worth £198; in the Nikkei 225, it would be worth £235 and in the S&P500 index in America it would have grown to a whopping £250. Even £100 invested in Italy’s FTSE MIB would be worth £189. For those tempted to argue that the FTSE100 is too dominated by foreign firms to be an accurate barometer of sentiment towards Britain, a £100 investment in June 2016 in the FTSE250 index of medium sized companies would today be worth a paltry £114.
Indeed, so dismal has been the performance of the London stock market in the last seven years that it is remarkable that it is not front page news, or the subject of anguished debate in parliament and the media. For years, British stock promoters have pleaded that UK shares are cheap, yet relative to the rest of the world they keep getting cheaper. UK equities currentlytrade at a 20 per cent discount to the broader European market on a price to earnings basis and a 15 per cent discount on a price to book basis, both near decades’ lows, according to Bank of America. Before Brexit, they traded at a premium. Compared to the broad US stock market, UK shares currently trade at a roughly 25 per cent discount on a price earnings basis.
The stock market is sending a devastating message about the way that Britain is perceived among global investors. No amount of boosterish bluster can hide the fact that Britain is a global outlier, nor should anyone be under any illusions about the consequences for the economy if this underperformance continues. This is no longer just an issue of concern for a few highly paid bankers in the City. It is an issue that goes to the heart of Britain’s economic model and long-term prospects.
Unique National Asset
To understand why this is so troubling, one needs to consider the central role that the stock market played in the making of modern Britain. When people talk about what transformed the country from the sick man of Europe in the 1970s into one of the biggest winners in the era of hyper-globalisation, they will typically talk about the stability of its institutions, its robust legal system, its elite universities, its entrepreneurial spirit, its openness to trade and historic links across the world. But lots of European countries had these. None had anything to compare with the London stock market.It was what turned Britain into a services superpower.
This unique national asset was a product of Britain’s commercial history. Its origins lay in Britain’s earliest imperial ventures, many now considered shameful, which were funded by subscriptions of shares. Its position at the heart of the British financial system was cemented by the genius Victorian invention of the joint stock company, based on the concept of limited liability. That provided entrepreneurs with access to a much larger pool of capital with which to sustain Britain’s leadership in the Industrial Revolution. Crucially, the growth of the stock market was fuelled by another vital British innovation: the accumulation of large private pension funds invested by companies in shares to pay the retirement incomes of their employees.
This was in marked contrast to continental bank-dominated financial systems - only the Netherlands had something comparable, albeit on a much smaller scale - and it was key to Britain’s modern renaissance.It was the existence of a deep and liquid equity market that enabled Margaret Thatcher to embark on one of her most radical reforms, privatisation, knowing that there were guaranteed buyers for the shares in former public utilities, including those sold to the general public. Those privatisations in turn drew significant sums of foreign capital to London. And as the global economy opened up following the fall of the Iron Curtain, Britain was able to export its successful model of shareholder capitalism to the rest of the world.
It was the globalisation of equity markets, far more than London’s earlier successes in the eurobond and foreign exchange markets, that transformed the fortunes of the City and Britain. As the shareholder capitalism revolution spread, London’s expertise not only in organising stock market flotations but in negotiating mergers and acquisitions created lucrative jobs for bankers, brokers, traders, lawyers, accountants, consultants and public relations experts. Foreign banks that wanted a piece of the action had no option but to set up shop in London. And as the City’s success grew, so it created demand for other services catering to the needs of the newly affluent and super-rich such as hospitality, real estate, retail and luxury goods.
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But now this process is threatening to go into reverse. Already the dismal valuations in London have contributed to a collapse in the number of listed companies, down nearly 50 per cent since 1997 and six per cent in 2023 alone. New listings have almost entirely dried up. Whereas £12 billion worth of shares were issued via initial public offerings in 2011, that had fallen to just £338 million last year and just £18.5 million this year.That compares to more than £4 billion of new listings on European bourses this year. Some IPO candidates have instead turned to private equity. Others, such as ARM Holdings, the semiconductor giant, chose to list in New York. Most worryingly, a growing number of companies are giving up their London listings in search of better valuations in New York, most recently CRH Holdings, Ferguson and Flutter.
For years, the expectation was that the valuation gap would be closed by foreign bargain hunters. But deals have been few and far between. Last month two potential bidders walked away from Currys after the board of the electrical retailer rejected a bid that was a 40 per cent premium over its previous closing price. Instead, boards are selling off foreign assets in an attempt to boost their share prices. Currys recently sold its Greek business at a much higher earnings multiple than that of the London-listed parent. Vodafone is to sell its Egyptian business, while Unilever will spin off its giant ice cream division, most likely via a listing in Amsterdam.
The London stock market is being deglobalised, a historic reversal of a decades-long trend. London ranked just 18th out of global stock markets for new issues last year. Meanwhile investors are voting with their feet. There have been net outflows from UK-based equity funds in 75 out of the last 90 months, with more than £80 billion yanked out since Brexit. In March alone an estimated £2.6 billion was withdrawn, bringing the total this year to £4.6 billion. The combined market capitalisation of stocks listed on the London stock market has shrunk over the past decade, down 17 per cent since 2013. Tellingly, it is the only major stock market in the world whose capitalisation has declined as a proportion of GDP over 20 years.
The impact of this is being felt right across the City, where livelihoods are under threat. At last year’s annual dinner of the Quoted Companies Alliance, the chair of the organisation that represents smaller listed companies, warned that the sector “does not stand at a crossroads but at a cliff edge”. Low valuations mean fewer listings, which mean fewer analysts willing to cover the market and fewer investors devoting time and capital to it, which makes it even less attractive to issuers. An entire ecosystem of professionals that was once the bedrock of the domestic capital markets and an important source of finance to Britain’s growth companies is imploding.
Nor is the damage limited to the small cap end of the market. The collapse in activity and dwindling fee pool has been driving consolidation among brokers. Last year, Numis was acquired by Deutsche Bank, while rivals Panmure Gordon and Liberum merged earlier this year. A lack of deals also means less work for lawyers, accountants and PR advisers and, of course, smaller bonuses. While few will shed too many tears for these individuals, it remains the case that what is bad news for the City is inevitably bad news for the Exchequer, given that the financial services industry has for many years generated 10 per cent of UK GDP and 12 per cent of its tax revenues.
Bad Ideas
But what could halt the decline? The problem for policymakers is that this is above all a verdict on the political chaos and uncertainty that has arisen in Britain since Brexit. The reality is that most institutional investors now look at asset allocation on a global basis, and with the UK comprising less than four per cent of global market capitalisation, many prefer to steer clear of a market that comes with so much political and currency risk. As one fund manager put it to me, there is little that you can buy in London that you can’t buy elsewhere. Whether it is exposure to oil, luxury goods, or engineering you are after, other stock markets offer it too.
Some in the City cling to the hope that a change of government might change investor perceptions of Britain. But while the removal of a weak, divided, right-wing populist Conservative government may be a necessary condition for a revaluation, it is highly unlikely to be sufficient. Capital goes where it is best treated. Investors will want to wait to see whether a stable, pragmatic, investor friendly government emerges after the election. One risk is that in an effort to shore up the stock market, a new government is tempted to take measures that make a bad problem worse.
Inevitably there have been demands in parts of the City for looser regulation to make London more attractive to new issuers. Jeremy Hunt has taken a step in that direction with his so-called Edinburgh Reforms. But the Financial Conduct Authority has acknowledged that some of the reforms, including facilitating the use of dual class shares, dispensing with shareholder votes on certain related-party transactions and scrapping the need for a three-year track record, will lead to what it euphemistically calls a “rebalancing of risk”. The result could be an increase in the number of poor quality deals that flop in the after-market, further damaging London’s reputation. Last year’s biggest London IPO, CAB Payments, fell 75 per cent in the following weeks.
Others have called for the government to find ways to drive more money into the UK stock market, whether through tax incentives or through issuing diktats to pension funds. They argue that these are needed to reverse the decline in domestic equity capital as a result of the decision by British pension funds to reduce their exposure to UK shares from 53 per cent to six per cent since 1997. Jeremy Hunt took a step down this path in his most recent budget with his announcement of the British ISA, an extra £5,000 of tax free saving provided it is invested in UK shares. Meanwhile Rachel Reeves has promised a review of the British pension system with the expressed intention of ensuring funds do more to support UK plc.
Yet this too carries risks. The regulatory reforms that led funds to switch out of equities and into fixed income were driven by the need to protect the taxpayer from picking up the bill for bust schemes following a string of scandals in the Eighties, notably the collapse of Equitable Life. Given that the most defined benefits funds are closed to new members and have been sold to insurance companies, it is hardly in the interests of beneficiaries or taxpayers that they should embrace more risk. Similarly, obliging defined contribution schemes to invest more in deeply underperforming UK shares could undermine public confidence at a time when the priority must be to encourage more saving. A wise government will tread very cautiously.
Self-inflicted Wound
Besides there is no reason to believe that efforts to cajole more domestic saving into UK shares would make any difference to valuations. After all, the process of de-equitisation by pension funds was largely complete by 2016 when the stock market first started to underperform. In any case, unlike in the early days of the shareholder revolution, we now live in a world of vast global capital pools. London’s problem today is not a lack of liquidity, it is investor sentiment. That is not going to be improved by tax breaks or recourse to what amounts to economic nationalism.
Of course, the one reform that could change investor sentiment is the one that dare not speak its name. While the Labour party talks of negotiating a better trading relationship with the European Union, any deal it might strike would fall far short of rejoining the single market. Instead, the Brexit damage is destined to get worse as the grace periods in Boris Johnson’s deal expire. Meanwhile European regulators will do what they can to lure business from London, as will fast-growing new rivals. Abu Dhabi, for example, is emerging as an important centre for the hedge fund industry.
The irony is that it was the very success of the stock market that sowed the seeds of the current crisis. Not everyone thought that the Britain that emerged during the years of stock market primacy was benign. As the wealth of London grew, so too did resentment in the rest of the country, fuelled by the global financial crisis of 2008 and subsequent bailouts. Not enough of the City’s wealth trickled down. Instead, inequalities grew, between sectors, regions and generations. This resentment was unquestionably a key factor in the Brexit vote of 2016, when half the country exacted their revenge on what they considered an arrogant global elite.
But Brexiteers also took the stock market for granted. They failed to recognise the extent to which its pre-eminence had ceased to hinge on British exceptionalism but on the anchoring of the British economy in a deep single market of 450 million people. Johnson was so convinced that the City could look after itself that he didn’t even seek a Brexit deal on financial services. The danger now is that the longer the underperformance continues, the greater the damage: to the City ecosystem, to tax revenues, and to productivity as a result of lost competitiveness and a higher cost of capital. The stock market will shape Britain’s future, just as it did its past.
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