The UK economy is facing challenges, but the stock market's low valuations may offer long-term opportunities. Despite challenges in Gilt supply, bonds remain attractive as Gilt yields are at their highest in a year, and there are still opportunities in credit.
In 2024, the UK economy performed better than expected, but growth remains subdued with a projected GDP increase of 1.3% for 2025. The potential imposition of U.S. tariffs could negatively impact the UK economy, though less so than EU countries due to the UK's lower export percentage to the U.S. and its service-oriented economy.
"The government may not have much room to manoeuvre to offset a tariff-related negative growth shock," it was noted, as fiscal leeway has been largely used up in recent budgets. The Bank of England (BoE) might be hesitant to loosen monetary policy quickly due to persistent services inflation.
The FTSE All-Share Index often performs well during global downturns because of its exposure to defensive sectors like Health Care and Utilities but tends to lag when growth sectors are favored due to low Technology exposure. UK equities are valued at historically low levels compared to other markets.
"Overall, we recommend holding an Underweight position in UK equities," with some large caps seen as attractive long-term investments due to valuation discounts compared to peers in other markets.
Regarding fixed income, the BoE faces incoming inflation data with risks ahead. The Office of Budget Responsibility indicates that fiscal policies could raise GDP growth but also push inflation above targets through 2029. Markets expect a 4.25% Bank Rate in early 2025 if inflation aligns with forecasts.
Gilt issuance is projected to stay above historical averages, yet demand remains strong despite 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.
Corporate bond yields appear compelling; however, spreads have narrowed significantly into expensive territory. "We believe the risk of widening from current tight levels is high." Caution is advised for allocations in Consumer Staples, Industrials, and Financials sectors.