Amid efforts to stimulate growth in the face of economic challenges, we see selective long-term opportunities in both equities and fixed income.
December 2, 2024
By Frédérique Carrier, Rufaro Chiriseri, CFA and Thomas McGarrity, CFA
The UK economy fared better than widely expected by investors in 2024, though the outlook remains subdued with consensus GDP growth of 1.3 percent estimated for 2025. The likely imposition of U.S. tariffs would negatively impact the UK economy, in our view, but the direct impact may be less than what EU countries may suffer. UK exports to the U.S. are only two percent of GDP, compared to four percent for Germany. Besides, the UK economy is more services-oriented than those of its neighbours.
But from our vantage point, the UK economy is also likely to suffer from an indirect impact. Exports to the EU may decline as the region’s overall growth is restrained by trade uncertainty. Even after Brexit, the EU remains the UK’s most important export market by far, accounting for 42 percent of all UK exports. Moreover, proposed U.S. tariffs and any potential retaliation may dampen UK business confidence.
The government may not have much room to manoeuvre to offset a tariff-related negative growth shock, having used much of its fiscal leeway in the recent budget. The Bank of England (BoE), with an eye on sticky services inflation, may be reluctant to loosen monetary policy too quickly.
The FTSE All-Share Index tends to perform relatively well during global downturns—not our base case forecast—thanks to its high relative exposure to defensive sectors such as Health Care, Utilities, and Consumer Staples. Conversely, it tends to lag in periods when growth sectors are favoured due to its low exposure to Technology in particular.
UK valuations remain close to all-time low levels compared to other markets. The FTSE All-Share Index is trading well below its relative long-term median price-to-earnings ratio versus global developed markets, even accounting for sector differences.
The line chart shows the valuation of the FTSE All-Share Index relative to the MSCI World Index since November 2014. Since reaching a high of 0.97x in 2016, the relative valuation has steadily declined and is now at a 10-year low of less than 0.6x.
Source – RBC Wealth Management, Bloomberg; data through 11/13/24
Overall, we recommend holding an Underweight position in UK equities, but we believe select quality large caps remain attractive long-term opportunities as they trade at a valuation discount to peers listed in other markets. We favour stocks exposed to UK consumer spending, which should benefit from Bank of England interest rate cuts over the next 12 months.
The Bank of England (BoE) is facing more palatable incoming inflation data, albeit with risks lying ahead. According to the Office of Budget Responsibility, the budget will raise GDP growth, but also reignite inflation above the BoE’s target over the 2025–2029 forecast period. Though the BoE refrained from remarking on the effects of stimulative fiscal policy and potential U.S tariffs on the economy, the message was clear in its November projections, in our view. According to the central bank’s forecasts, inflation should return to target in Q1 2027, a year later than suggested in the August estimates.
Markets are pricing in a 4.25 percent Bank Rate in H1 2025, which seems reasonable if incoming inflation data is broadly in line with the BoE’s forecast. Policy easing could be limited in 2025 if there are persistent upside inflation surprises fueled by tariffs and government spending, relative to BoE forecasts.
The Debt Management Office’s forecast over the next few years shows that gross Gilt issuance will remain above the historic 10-year averages (excluding 2020, a year with heavy issuances due to the COVID-19 pandemic). Gilt demand remains robust, even with the overhang of £142 billion of additional borrowing on the horizon. We think the fiscal and supply glut risks are largely priced in over the near term, with 10-year Gilt yields at one-year highs, and we have favoured adding duration in portfolios.
Corporate bond yield compensation for duration is around one-year averages, thanks to higher Gilt yields. While all-in yields look compelling to us, spreads have narrowed markedly, shifting further into expensive territory, and we believe the risk of widening from current tight levels is high. A potential headwind lies ahead for corporates that struggle to pass on increased labour costs due to larger employer national insurance contributions and a higher minimum wage. We are cautious and selective on allocations in the near term and favour allocations in Consumer Staples, Industrials, and Financials.
The line chart shows the yield of the Sterling Aggregate Corporate Index and Sterling Gilts Index from January 2024 through November 2024. Corporate yields are currently at 5.58%, compared to 5.23% in January and a high of 5.77% in May. Gilt yields are currently at 4.56%, compared to 3.90% in January and a high of 4.61% in May.
Source – RBC Wealth Management, Bloomberg; yields represented by the Bloomberg Sterling Aggregate Corporate Index and Sterling Gilts Index; data through 11/13/24
View the full Global Insight 2025 Outlook here
We want to talk about your financial future.
This publication has been issued by Royal Bank of Canada on behalf of certain RBC® companies that form part of the international network of RBC Wealth Management. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by Royal Bank of Canada, its affiliates or subsidiaries.
The information contained in this report has been compiled by Royal Bank of Canada and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgments as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.
This material is prepared for general circulation to clients, including clients who are affiliates of Royal Bank of Canada, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither Royal Bank of Canada nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of Royal Bank of Canada.
Clients of United Kingdom companies may be entitled to compensation from the UK Financial Services Compensation Scheme if any of these entities cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. Deposits made with Royal Bank of Canada (Channel Islands) Limited in Jersey are not covered by the UK Financial Services Compensation Scheme. Royal Bank of Canada (Channel Islands) Limited is a participant in the Jersey Bank Depositors Compensation Scheme. The Scheme offers protection for ‘eligible deposits’ up to £50,000 per individual claimant, subject to certain limitations. The maximum total amount of compensation is capped at £100,000,000 in any 5 year period. Full details of the Scheme and banking groups covered are available on the Government of Jersey’s website www.gov.je/dcs or on request.