Bright Spots on the Horizon for the UK Economy

The UK economy currently feels like it’s mired in all-round gloom. Any bounce from Labour’s landslide election victory in July quickly evaporated after an unpopular budget and data showing the economy nearly stalled in the third quarter.

However, while the doomsayers tend to dominate the general discourse, there are glimpses of good news for investors, if one knows where to look.

Record corporate share buybacks and rising household savings for example point to underlying financial resilience despite broader economic uncertainties.

Figure 1: Companies pivot to share buybacks over dividends

Source: Bloomberg as of 31 October 2024

Recent shifts in corporate behaviour reveal a marked change in how UK companies manage their capital amidst higher interest rates and improved earnings.

Historically, low interest rates made borrowing attractive; however, as rates have reset, companies are now more reluctant to increase their debt levels. This strategic shift has resulted in net debt to EBITDA (earnings before interest, taxes, depreciation, and amortisation) ratios reaching decade lows, reflecting healthier balance sheets across most sectors, with the notable exception of pressure in utilities like gas and water.

Simultaneously, robust earnings growth has provided companies with strong cash flows. Traditionally, these funds would be channelled into dividends, but we have seen a pivot towards share buybacks.

Data shows 45% of FTSE 350 firms have reduced their share counts in the past two years. By redirecting cash flows to repurchase shares, companies are capitalising on low market valuations to enhance shareholder value and boost earnings per share.

Notable examples of buyback activity this year include Natwest and Imperial Brands who have seen their shares advance by about 80% and 50% respectively.

Putting the money in the bank

In parallel, UK households in aggregate have never been in a stronger financial position.

Traditionally a nation of spenders on tick, the UK is now turning into a nation of savers. Deposits are outpacing household credit, highlighting a substantial but untapped reservoir of consumer spending power.

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Households hunkered down as Brexit, COVID-19 and the cost-of-living crisis
eroded consumer confidence even with above-average pay increases over
the past three years.

The latest Bank of England data shows that household deposits with banks and building societies jumped by £20.2 billion in October, the largest increase since December 2020 (£21.7 billion), both of which were higher than any pre-pandemic figures on record. By contrast, net borrowing of consumer credit by individuals decreased to £1.1 billion, from £1.2 billion in the previous month, with growth rates for different types of consumer credit either stalling or falling.

Looking at household cashflow data crunched by Lazarus Economics, we have passed the peak in inflationary inputs (driven by a 40% jump in energy costs in 2022, falling by an estimated 20% this year) and have started to enjoy the benefits of higher earnings from recent years.

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The question now is when consumers will start spending this extra cash
rather than parking it in the bank.  To prompt a change in behaviour, we think further Bank of England rate cuts are key. Apart from lowering mortgage costs, it would signal that prices are becoming more stable. And that will go a long way to banish some of the gloom.

UK renters and affordable housing investors main winners from new bill

Speaking of glimpses of light, the Renters Reform Bill, which aims to strengthen tenant rights, is currently weaving its way through the parliamentary system and has many private landlords and investors worried — but, as with every change, there will be winners and losers.

Increased mortgage costs have forced more people into the UK rental sector, which is already afflicted by a shortage of housing, regularly pushing rents to new records.

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The bill’s proposals will substantially alter how rents are managed. Right now, landlords have been able to increase rents and re-gear portfolios easily, often leaving tenants with the stark choice of eviction or acquiescence. The new rules will restrict evictions to a few specific areas, reducing landlords' leverage and providing tenants with more security.

Who will lose out?

Based on the current shape of the bill, the multi-family investment sector, i.e. large apartment blocks, will be hit hardest. The bill will curtail the ability to continuously cycle through rental increases, making the operating model more challenging. Landlords will probably face greater void periods and higher operating costs due to potential rental challenges and the need to defend cases in a tribunal.

Historically, multi-family housing investments have been able to take advantage of the shortage of UK rental homes by proactively managing rental increases.

For example, in the year from the third quarter of 2023 to the second quarter of 2024, gross rents in multi-family investments increased by 8.0% (source: MSCI).  This compares to a total return of -1.0% (source: MSCI).  Without that level of rental growth, multi-family investments would have performed materially worse.  Valuations in the multi-family sector may come under pressure as these changes take place.

And the winners are…?

Firstly, tenants.

Secondly, in contrast to the multi-family sector, the impact will be less pronounced in the affordable housing sector, such as social housing and shared ownership, where rent increases are based on a CPI (Consumer Price Index) +1% formula, which the government has confirmed will not change. Long-term tenancies are common in this sector, so the abolition of short-term tenancies will have a limited effect.

Housing is one of the most challenging issues currently facing the UK, and the bill will help strengthen the case for more institutional investment flow into affordable housing, targeting a positive social impact, while also securing financial returns

All data Bloomberg unless otherwise stated.

With contributions from Henry Dixon, a Portfolio Manager on the UK discretionary equities team and Shamez Alibhai, Managing Director, Head of Community Housing at Man Group.