The stock markets of the United Kingdom and France are the largest in Europe. The UK and French economies are among the largest in Europe. The two countries on opposite sides of the Channel share a centuries long history of economic and political competition. Their stock markets currently face some common headwinds and challenges. There are important differences in these markets, however, particularly since the United Kingdom exited the European Union in 2020 (Brexit).
We consider first a comparison of the outlook for the two economies. Revised data GDP for the third and fourth quarters of 2022 indicate the UK economy entered the current year stronger than previously thought. GDP for March did surprise on the downside, falling 0.3% from the previous month. Nevertheless, growth for the first quarter remained positive at 0.1% q/q. The current quarter’s growth is being affected by industrial action and an extra bank holiday because of the coronation. However, the economy is demonstrating considerable resilience and looks likely to pick up momentum in the second half. This past week the Monetary Policy Committee (MPC) of the Bank of England (BOE) raised its forecasts for economic growth and inflation. It is looking more unlikely that the UK will experience the widely forecast recession this year. GDP growth for the year is now projected at a positive 0.3%. The recovery will likely be uneven, heavily weighted towards services, the sector which accounts for 80% of the economy. Manufacturing accounts for only 10%.
The BOE raised its Bank Rate last week by 25 basis points to 4.50%, its twelfth consecutive rate increase. Interest rates haven’t been this high since 2008. While the soft economy would suggest this rate increase could be the last, the MPC’s higher inflation forecast may imply the peak has not yet been reached. The new forecast inflation of 5.1% in the fourth quarter of 2023 is significantly higher than the previous projection of 3.9%. Wage growth currently is considerably higher than a pace with which the BOE would be comfortable and is looking likely to still be at a 4% rate at year end. Further tightening of credit conditions in the coming months would be additional to the effects of tighter fiscal policy which is projected despite the loosening effects of the March Budget. An expected slowdown in the global economy, particularly for the advanced economies, will be a further headwind along with the medium term negative effects of Brexit (increased trade friction, some trade destruction and less attraction for foreign direct investment). We expect GDP growth next year for the UK will be at around 1.3%, slightly below estimated potential growth of 1.5%.
While the French economy has thus far this year also proved to be more resilient than expected, with first quarter growth of 0.2% q/q, there are signs the economy may be approaching a turning point. The latest opinion surveys point to weakening expectations for both demand and production. Although easing supply bottlenecks, moderating energy price inflation and pent up demand because of the pandemic are positive factors going forward, external demand is unlikely to provide a significant boost to the French economy. The global economic slowdown is likely to mean that world trade will be flat this year, a negative development for open economies like that of France.
As is the case for the UK economy, there is a marked gap between the performance of the services and manufacturing sectors of the French economy, with services output continuing to be strong. The post pandemic pent-up demand for services such as tourism eventually will be exhausted. As services account for 80% of the French economy, an eventual easing in the demand for services is expected to be one of the factors leading to GDP growth of just 0.5% this year and 1.0% in 2024. Already the never-ending anti-pension reform demonstrations which include instances of violence is impacting tourism.
Continuing high inflationary pressures and tightening credit conditions are additional headwinds for the French economy. The European Central Bank (ECB) raised its policy rate by another 25 basis points in last week Since last July, the rate increases have totaled 3.75 percentage points. The ECB may be getting close to the ending of its tightening policy. The effects of this tightening will continue to be felt for some time in bank lending conditions and corporate and household investment decisions.
The outlook for positive but very moderate economic growth for the period through the end of next year is broadly shared by the UK and France. Such similarity is not the case for the performance of the two respective national stock markets thus far this year. For the UK the FTSE 100 index is up 4.06% for the year-to-date through May 12. In contrast, for France the CAC 40 index is up 14.54% over the same period. French equities have done considerably better and UK equities considerably worse than the US market where the S&P 500 index is up 7.41%.
There are several factors that may account for difference in performance. If we look at the sector composition of the two markets, the UK market is more heavily weighted towards financial firms, 18.2% of the MSCI UK index, as compared with the financials 10.4% share of the MSCI France index. Industrials and consumer discretionary goods (including lux goods), on the other hand, are more important in the French market, 43.3%, than in the UK, 16.1%. Mining stocks also have had a negative effect on the UK index.
While the price to earnings ratios for both markets are below their three-year averages, the current figure for the UK at 10.6 is less than half the figure for the French market, 24.2. A large part of the blame for the UK market’s weaker performance is that nation’s decision to exit the European Market in 2020. This led to plunging valuations for UK stocks, and to UK firms delisting there and listing in the US or elsewhere. Measured by price/earning ratios, there is now a “Brexit discount” of 35 % for London stocks versus world stocks.
Last November the UK stock market lost its position of being Europe’s biggest stock market to the French stock market. In March, the total market capitalization of the Paris market reached 3.13 trillion US$, some 250 billion US$ more than London’s market cap. The difference could well increase as the European Central Bank is urging investment banks to shift more of their assets from London to European Union markets where the ECB can have better oversight of financial risks for the EU. Hundreds of billions of dollars of assets could be moved. In the meantime, little progress is evident on a promised UK and EU memorandum of understanding on regulatory cooperation.
William H. Witherell, Ph.D.
Vice Chairman & Chief Global Economist
Email | Bio
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Sources: Oxford Economics, Bloomberg.com, Reuters.com, Goldman Sachs Economics Research, Financial Times, Action Economics, CNBC.com, iShares.com.
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