Keep Calm and Carry On – Take 2

In our last note we outlined our rationale for keeping calm and carrying on buying what we believe to be extraordinarily cheap UK equities, particularly in the mid-market space, in the face of increasingly negative headlines. Regular readers will know we have previously been guilty of thinking that pessimism towards all things UK related had surely reached a peak, only for it to find another level, and it appears to have done so again recently.

Whilst discontent with the UK has been increasing post a series of missteps by the Labour government, the finger of blame for further anxiety is pointing squarely at the seemingly inexorable rise in government bond yields. Whilst very much a global (ex-China) phenomenon, the issue has garnered particular attention in the UK given the potential impact of rising borrowing costs on the government’s fiscal plans. As the chart below highlights, long dated Gilt yields have risen aggressively of late, more than surpassing the ‘Liz Truss’ peak of 2022, reaching levels last witnessed in the twentieth century.

Alongside the move in yields there has been a relatively recent decline in the value of Sterling, which has moved from being one of the strongest currencies in the G10 during 2024 to the weakest – by some margin – at the start of 2025, as the chart below highlights.

This potentially toxic combination of rising bond yields and a weakening currency has sent an already angsty media into a veritable frenzy, with talk of sacking the Chancellor, inevitable recession, parallels with the mid 1970’s, IMF bailouts and more. The impact on UK assets has been, unsurprisingly, severe as can be seen in the chart below of the performance of the domestically focussed MID-250 (ex-Investment Trusts) Index over the past year.

Just eight trading days into 2025 the index was down -5.5%, and down -8.0% since early December. Observant readers will note the recent peak in performance came on 31st July 2024, just 2 days after the new Chancellor’s infamous ‘£22bn black hole’ speech, since when the index is down -10.6% in total, with many of the pure UK exposed stocks, particularly in housing related areas, down in the region of -30% to -40%.

If you believe, as we do, that stock markets are primarily discounting mechanisms, then this performance is, perhaps, entirely consistent with the economic worries once again upon us. The question therefore should be what happens next? At the risk of sounding blasé about current conditions in UK financial markets, we do not profess to know what is in the immediate future and neither, frankly, does anyone else. However, in an attempt to offer some semblance of balance to the current hysteria, we would make the following observations.

Whilst the rise in Gilt yields is unwelcome from a cost of finance perspective, it is clearly not just a UK related issue. Indeed, whilst 10-year Gilt yields have risen over 100 basis points (bps) since the 3.75% low in September 2024, 10-year US Treasury yields (arguably the most important interest rate globally) have had a near identical move over the same period. Furthermore, comparisons with the 2022 ‘Liz Truss’ period seem somewhat sensationalist given inflation was c.10% then, not 2.6% as it is today, and yields increased 150 bps in one month, not 100 bps over four months. Additionally, whilst UK public sector debt to GDP is relatively high, it is still the second lowest of the G7 countries.

We mentioned in our last note our expectation of a relatively resilient UK consumer, given solid real wage increases, a healthy savings rate and still reasonably robust employment and housing market trends. It does not, therefore, surprise us to see generally solid trading statements over the important Christmas period. Most retailers appear to have traded well, if not spectacularly, although what has really grabbed our attention is the very strong trading at the major pub companies, with like-for-like sales growth of 10% or more in several instances. It is far from clear to us, based on what we hear from companies currently, that a material period of consumer weakness is imminent.

Undoubtedly though, business sentiment has deteriorated rapidly over recent months, particularly as the scale of increased employer tax burdens became apparent in the recent budget. The impact can be seen clearly in the chart below of the Institute of Directors Economic Confidence Index. With confidence currently plumbing both ‘Covid’ and ‘Liz Truss’ lows, again we need to consider where it is most likely heading next. Whilst we can offer no guarantees of course, and as unlikely as it may feel today, confidence typically improves from these levels and often quite vigorously, rather than deteriorating yet further.

In recent years we seem to have spent a disproportionate amount of our time defending the outlook for the UK economy, and by extension domestic equities. We understand the rationale for bearishness given it has been such an extraordinarily challenging period, with Brexit, the pandemic, wars, energy crisis, cost of living crisis, high inflation and interest rates, political upheaval and more. Yet throughout it all the economy has muddled along ok. It has not been great by any means, but it has certainly not been as disastrous as many feared, and we strongly suspect this current period will prove no different.

Meanwhile, in the face of such persistent negativity, alongside the well documented relentless outflow of capital, the valuations afforded to UK assets, and specifically domestic orientated mid and small capitalisation companies, have continued falling to such an extent that we believe we have a generational value opportunity emerging. Sentiment towards the UK is clearly awful right now and certainly it can (and frequently does!) deteriorate further. However, as we view the world, we can be nothing other than extremely excited at the investment returns we think are available in buying UK assets today and holding them over the medium term.

So yes, keep calm and carry on buying is very much our current mantra, with the new year ‘sales’ offering an even more attractive entry point for those with a nose for a bargain.