Morgan Stanley (NYSE:MS) analysts believe that the U.K. is undervalued relative to the rest of Europe. Growth prospects in the U.K. are more favorable relative to the rest of Europe, according to Citi Research. Housing, consumer spending, and exports are growth drivers. Housing turnover and prices have been boosted by the government’s “Help to Buy” scheme, and the housing upturn is driving consumer spending. Export growth excluding oil and erratic goods has grown 3.7 percent quarter over quarter, the strongest showing since the fourth quarter of 2011. Citi’s GDP growth forecasts are 1.1 percent for 2013 as a whole, 2.1 percent in 2014 and 2.7 percent in 2015, up from 0.9 percent, 1.3 percent and 1.8 percent respectively on July.
The recovery in economic growth is already driving productivity gains
Monetary conditions in the U.K. remain accommodative and the Monetary Policy Committee will stay on hold until the unemployment rate falls below 7 percent, in Citi’s view. However, it is unlikely that the unemployment rate will decline to that level as soon as consensus expects. Capacity from productivity gains, greater use of under-employed labor, and labor force growth may precede the need for extra capacity to meet accelerating demand for goods and services.
Real GDP per hour (a measure of productivity) declined by 5.1 percent during the last five years. The average growth of real GDP/hour has been 2.7 percent year over year over the past 20 years. Some structural post financial crisis conditions such as low business activity, restricted financing availability, and lost productivity in financial sector may have played a role in the productivity decrease. Sluggish economic growth magnified the effect of the structural conditions driving the productivity decline.
The recovery in economic growth is already driving productivity gains, in fact output per hour grew at the fastest pace since 2011 at 0.3 percent. Further productivity gains are possible in the 1-2 percent range in the next year or two, according to Citi analysts. Underemployment remains high in the U.K., as evidenced by a 9.0 percent spike in self-employment, 4.1 percent rise in part time workers and 10.7 increase in temporary workers over the last five years.
Citi analysts suspect that part of the percentage increase in self-employed, part time and temporary workers is due to people taking such employment in lieu of full time employment amid economic weakness. As the economy recovers, some workers may shift from part time or temporary work to full time employment.
UK equities are slightly undervalued relative to the rest of Europe
U.K. equities remain fairly valued, close to the 13 Shiller Price to Earnings ratio. In other measures, particularly in price to earnings and dividend yield, U.K. equities are slightly undervalued relative to the rest of Europe. Price to earnings of Europe excluding U.K. is 17 while price to earnings of U.K. is 13.1. Also, dividend yields are higher in the UK at 3.7 percent versus 3.3 in Europe excluding UK.
Finally, the return on equity for U.K. is 13.7 percent versus 9.4 percent in Europe excluding the U.K. From these measures and their analysis, Morgan Stanley (NYSE:MS) analysts conclude that U.K. stocks trade at a discount relative to Europe and offer opportunities for both price appreciation and income.
