It is hard to get a man to understand something, wrote Upton Sinclair, an American novelist, when his salary depends on not understanding it. Hard, but not impossible: just look at those paid to promote Britain’s stock market. Bankers and stock exchange bosses have an interest in declaring it an excellent place to list new, exciting businesses, as do politicians. Yet deep down they seem keenly aware that it is doomed.
Government ministers once spoke of “Big Bang 2.0”, a mixture of policies aiming to rejuvenate the City of London and, especially, attract initial public offerings (IPOs). But if anyone ever thought an explosive, Thatcherite wave of deregulation was on its way, they do not any more. The new rules are now known as the more squib-like “Edinburgh reforms”. On December 8th the chair of the parliamentary committee overseeing their implementation chastised the responsible minister for a “lack of progress or economic impact”.
In any case, says the boss of one bank’s European IPO business, he is unaware of any company choosing an IPO venue based on its listing rules. Instead, clients ask how much money their shares will fetch and how readily local investors will support their business. These are fronts on which the City has long been found wanting. Even those running Britain’s bourse seem to doubt its chances of revival. Its parent company recently ran an advertising campaign insisting that its name is pronounced “L-SEG” rather than “London Stock Exchange Group”; that it operates far beyond London; and that running a stock exchange is “just part” of what it does.
London’s future as a global-equity hub seems increasingly certain. It will be drearier. If everyone agrees London is a bad place to list, international firms will go elsewhere. But what about those already listed there? Their persistent low valuation is a big part of what is off-putting for others. And it is much harder to explain than a self-fulfilling consensus that exciting firms do not list in London.
The canonical justification for London-listed stocks being cheap is simple. British pension funds have spent decades swapping shares for bonds and British securities for foreign ones, which has left less domestic capital on offer for companies listing in London. Combined with a reputation for fusty investors who prefer established business models to new ones, that led to disruptive tech companies with the potential for rapid growth listing elsewhere. London’s stock exchange was left looking like a museum: stuffed with banks, energy firms, insurers and miners. Their shares deserve to be cheap because their earnings are unlikely to rise much.
All of this is true, but it cannot explain the sheer scale of British underperformance. The market’s flagship FTSE 100 index now trades at around ten times the value of its underlying firms’ annual earnings—barely higher than the nadir reached during March 2020, as the shutters came down at the start of the covid-19 pandemic. In the meantime, America’s S&P 500 index has recovered strongly: it is worth more than 21 times its firms’ annual earnings. The implication is that investors expect much faster profit growth from American shares, and they are probably right. Yet virtually every conversation with equity investors these days revolves around how eye-wateringly expensive American stocks are. Should earnings growth disappoint even a little, large losses loom.
Britain’s FTSE 100 firms, meanwhile, are already making profits worth 10% of their value each year. Even if their earnings do not grow at all, that is well above the 4% available on ten-year Treasury bonds and more than double the equivalent yield on the S&P 500. At the same time, higher interest rates ought to have made the immediate cashflows available from British stocks more valuable than the promise of profits in the distant future. Why haven’t they?
No explanation is particularly compelling. British pension funds might no longer be buying domestic stocks, but international investors are perfectly capable of stepping in. Some sectors represented in the FTSE—tobacco, for instance—may see profits dwindle, but most will not. Britain’s economy has hardly boomed, but it has so far avoided the recession that seemed a sure thing a year ago. Global investors seem content to ignore Britain’s market, despite its unusually high yield and their own angst about low yields elsewhere. Yet spotting such things is what their salaries depend on. There is something Sinclair might have found hard to understand.
Read more from Buttonwood, our columnist on financial markets: Why it might be time to buy banks (Dec 7th) Short-sellers are endangered. That is bad news for markets (Nov 30th) Investors are going loco for CoCos (Nov 23rd)
Also: How the Buttonwood column got its name
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