<h4>Could 2024 be a golden year for UK equities?</h4>
It’s been a long time coming, but as we start the new year, I can already see many reasons why 2024 
could be a golden year for UK Equities, as the UK finally gets its mojo back. 
As you might expect my UK Recovery and UK Alpha funds are well positioned for this Golden Year: 
overweight value, recovery, beneficiaries of lower interest rates and smaller companies and all the 
other stock picking opportunities highlighted below.
<h4> </h4>
<h4>My 15 reasons why UK Equities will perform.</h4>
1. Distressed Valuation
Starting valuations are extremely low, both in absolute (10.5x Price Earnings) and relative terms (half 
what you pay for US equities) and with a yield (3.9%) that is again higher than government bond 
yields (10yr).
2. Inflation falling
Inflation has peaked and is falling faster than expectations.
3. Interest rates falling
Interest rates will be cut in 2024.
4. Mortgage rates falling
Mortgage rates have already been falling and will continue to do so.
5. Consumer confidence picks-up
Wage inflation is falling but lags other inflation allowing for consumers to feel better off.
6. Tax cuts
Taxes have started to be cut, this will become more aggressive in the spring budget.
7. Political feelgood
There is likely to be a change of Government, which will stimulate a feel good factor. If the 
Conservatives cling on then Rishi Sunak will have a strong mandate to deliver an administration that 
fits his core competence, running this country effectively.
8. Economic Growth
All the above means that the UK economy will be growing robustly as we move into the second half 
of 2024.
9. Policy Support
The lack of institutional investment support for UK equities has become a political issue, a worry that 
minimal allocations to our UK listed stock market alongside very low valuations is undermining the 
efficient workings of UK capital markets. Expect policy support here to become more explicit.
10. Breadth of stock picking opportunities
A key under-pinning for a Golden Year for UK Equities is the sheer breadth of the stock picking 
opportunity set, from traditional deep value stocks such as banks, to classic recovery shares such as 
housebuilders, to bond proxies such as Real Estate and Infrastructure, to unloved China plays, to de- 
rated structural growers such as digital platform stocks, to lowly valued asset gatherers, to bargain 
basement consumer facing stocks such as airlines, to cheap commodity producers, and then there 
are the Investment Trusts (big discounts to NAV still available) and last but not least smaller 
companies, a multitude of de-rated opportunities all available to corporate predators until the 
market values them more correctly. The bigger the opportunity set the bigger the likely medium 
term returns.
11. Timing
Timing is improving for nearly all the stock picking opportunities that we track i.e. things are getting 
a bit better at a stock level, earnings may have stopped being downgraded, investor sentiment is 
bottoming out, all this reflected in share prices that have started to rally. This is the perfect recipe, 
rock bottom valuations AND improving timing.
12. Profits
The corporate profits and cash flow outlook will improve as we go through the year. Whilst 
corporates are having to work hard to maintain profits against the background of a weaker 
economy, they do now have more flexibility on costs and this should enable margins to improve as 
we go through 2024, and into 2025 as revenue starts to grow again. Cash flow has remained robust 
and share buy backs, often at very discounted valuations continue at pace.
13. Catch-up
The great thing is that UK equities, unlike say US equities are giving investors plenty of time to get on 
board. UK small companies are up a bit over 10% from the low point, this compares with some long 
duration Gilts that are up 30% (i.e. UKT 0.5% 2061) over the same time period. Meanwhile most US 
large cap stocks are back at all-time highs, with pretty full valuations, much of the recovery cycle has 
arguably played out in the most liquid parts of the US market. In the UK this has yet to come.
14. Flows will turn, in an illiquid market
Outflows from UK Equities, smaller companies in particular have continued at record levels for over 
two years now. The resulting forced selling has artificially depressed share prices. Money has flowed 
into cash because short term yields are high and into low cost global equity products, because that’s 
where returns have been best over the last few years. However, yields on cash are falling now and 
US equities have already rallied so the relative attractiveness of UK equities is improving. And as the 
marginal seller becomes a marginal buyer the positive impact on illiquid UK equities, such as smaller 
companies will be material.
15. Animal Spirits
We are all going to get bored with the unremitting negativity towards the UK. We are the world’s 
sixth largest economy and are very good at lots of things. As things get better and UK equities start 
to perform the narrative will improve. A combination of rock bottom valuations and things getting 
better will catalyse a Golden Year for UK Equities.

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The fund invests primarily in UK companies that are based in the UK, or have significant operations in the country, with a bias to companies that are in the recovery stage of their life cycle.

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Could 2024 be a golden year for UK equities?

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Analyst: “[H]ow much flexibility do you see within your capex overall? Normally, in a down cycle, we see sustaining capex come down. We see … growth projects … moderate and so on. But how should we think about your capex in this cycle?”
Jackob Stausholm, Rio Tinto CEO: “[L]ook this is actually really fundamental. If we start adjusting our capex program because we think there is a recession in the next six months, we have lost it. We are in for the long haul here.”[1]
Capitalism’s karma, according to the strategy team at BNP Paribas Exane, is that “every cycle we end up paying for the sins of the previous cycle”. 2010-20 saw consumers deleverage household balance sheets while governments engaged in austerity to try and balance their own books. With a consequent lack of nominal growth, corporates shunned re-investment in capital expenditure (‘capex’) and embraced buybacks as a superior use of cash. We believe this has set up an investable opportunity today due to 3 converging elements: [1] today’s inflationary pressures are a symptom of last cycle’s underspend and a need for upgraded manufacturing bases (‘smart industrial’) and infrastructure is joined by decarbonisation, supply chain resilience or ‘near-shoring’, and energy security as critical investment priorities for the near, medium and long term[2]; [2] investor mindsets are conditioned by the past decade to expect that capex will undershoot expectations, particularly as macro expectations and cyclical companies’ earnings expectations roll over; [3] we have evidence that capex forecasts are proving more resilient than earnings forecasts, while market falls have made the risk-reward for companies exposed to this opportunity particularly attractive today.
How did we get here? Examining some key periods from the past two decades, we can make the following observations:
<ul>
	<li>Pre-GFC (2003-08): capex grew at an average rate of ~19% in the pre-GFC “golden era” (‘03-08). This wasn’t just driven by extractive industries – despite mining and oil &amp; gas leading growth, industrial capex (i.e., ex-extractive industries) still grew at a healthy ~15% rate.</li>
	<li>Post-GFC recovery (2009-13): while companies cut spending in ’09 (global capex down ~15%, or ~20% excluding extractive industries), good growth in 2010-13 (+7%) led by extractive industries meant that capex had recovered to ’08 levels by 2013 (though capex outside extractive industries was still some 7% below pre GFC levels).</li>
	<li>Extractive industry capex unwinds (2014-21): the mining capex unwind came first (2013) then a year or two later came oil &amp; gas. This capex reduction in extractive industries pulled down global capex to a 1% decline per annum on average. Excluding extractive industries, capex growth was ~4% over this period but was heavily influenced by semiconductors and technology (e.g., datacentres); excluding these industries, the balance grew at a ~2% rate.</li>
	<li>Where are we today: global capex is still 3% below its 2008 peak in dollar terms. Extractive industries have been a major drag but excluding these and semis &amp; tech, core industrial capex is only 1% above the ’08 peak.</li>
</ul>

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But this is only part of the story. What we see in the charts above is the outcome (the actual capex dollars spent) which misses another critical element involved in the movement of equity prices – how expectations change. Below we show the capex forecasts for some major spenders between 2014-2018. Consistent moves down in expectations were the defining feature and our assessment is that this is embedded in investor memory and the mental shortcuts they consequently apply.

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This is important context for the dynamics we are witnessing today. Forecast revisions for cyclical sectors have weakened relative to defensive sectors, notably since the middle of 2022, leading to broad-based share price underperformance for economically sensitive companies.

Despite this, unlike 2009, capex forecasts are proving more resilient than earnings forecasts. We have aggregated the bottom-up analyst forecasts for capex in 2022, 2023 and 2024 for every company in the MSCI ACWI index to look at how these have moved over the past year. For 2023, for example, the aggregate level is +7% higher versus a year ago and the levels for all have hardly budged in US dollar terms since the end of Q1 2022 despite softening macro and the strong dollar. 2024 spend is expected to be higher than 2023, which in turn is higher than 2022.

When we drill down to a handful of key sectors and sub-sectors (below), the growth figures are like previous capex cycles while there is also a clear logic and narrative behind the current spend. The inflationary pressures we’re experiencing today are a symptom of last cycle’s underspend – the requirement to upgrade manufacturing bases (‘smart industrial’) and infrastructure is joined by decarbonisation, supply chain resilience or ‘near-shoring’, and energy security as critical investment priorities for the near, medium, and long term. Returning to the Rio Tinto CEO’s quotation at the top, “this is actually really fundamental” – rapid payback investments[3], helping build business resilience, or giving companies a licence to do business for the decades to come if we consider energy transition investments for oil &amp; gas companies or investment in electric vehicle platforms for autos. Or as Morgan Stanley puts it, “Even if we were to dip into a recession, we are of the view that these investments still need to take place as the problems do not get resolved with a moderating demand environment. In other words, the capex investments we envision and believe are necessary are incremental and largely cycle/capacity addition agnostic.”

The numbers involved are large. Morgan Stanley forecasts the following:
<ul>
	<li>~7.5% manufacturing capex CAGR over the next 3-5 years vs historical levels ~4%, and within this automation growing at ~10%</li>
	<li>Retrofit to enable EV infrastructure, onsite power generation and storage, and grid modernisation providing a 20-year runway of ~6% growth in electrical markets, incremental to industrial production growth and accelerating from 2025-30 (~$45bn opportunity between now and 2030)</li>
	<li>$350bn spending over the next 15 years to modernise the commercial building installed base, an additional $140bn over status quo investment requirements</li>
	<li>~$39bn from the CHIPS Act to bolster domestic US semiconductor manufacturing (plus $13bn for R&amp;D) versus a current ~$200bn manufacturing capex base</li>
	<li>~$370bn earmarked for Energy Security and Climate Change investments within the US government’s Inflation Reduction Act to incentivise the transition to greener energy sources</li>
	<li>~€200 billion by 2026 from the German government for investments in decarbonisation and energy dependence.</li>
</ul>
Some of the major investment opportunities come in what we might consider ‘derivative spend’. For example, we know that spend on renewable energy generation is ramping fast (captured above in Energy’s +23% increase in 2023 forecasts over the past year). A future grid with 20-30% solar is considered optimal, which requires a 3-5x acceleration in the pace of annual solar deployments. However less well known is that solar output typically flickers downwards by over 10% around 100 times per day[4] and building out power grids and inter-connectors is considered the best means of helping to resolve both short- and long-term variability in output. Thunder Said Energy estimates that power network investment can rise from an average $280bn per annum in 2015-20[5] to $600bn by the end of the decade, equivalent to all upstream oil &amp; gas capex in 2015[6]. Portfolio holding NKT is well placed to benefit from demand for its high-voltage cable solutions.
<a href="https://river.global/cleansing-capitalisms-karma/#_ftnref1" name="_ftn1"></a>

Anticipation of a global recession has made accessing this long-term growth very cheap, with the prospect that for the select cyclicals that are beneficiaries, near-term earnings also look set to be more resilient than analysts are forecasting or share prices are embedding. Below are the price/earnings multiples (based on consensus earnings 1 year ahead) for a handful of companies held in the portfolio which are positively exposed to the trends mentioned:

And from a timing perspective, using the broad Capital Goods industry group as a proxy, capex beneficiaries have underperformed the bear market, but investors have nascently begun to differentiate their outlook versus other cyclical sectors. This suggests the idiosyncratic outperformance is in its early innings.

This entry point offers a positively skewed risk-reward: “heads we win, tails we don’t lose too much.” Nonetheless, it’s worth considering where we could be wrong. Firstly, and most obviously, monetary policy works with a lag – that’s to say, the capex cuts are coming, we just haven’t seen them yet. Do companies have the capacity to make the investments, even if they want to? Current analysis is relatively comforting on this point. Goldman Sachs “see the ability for public companies to spend $1.0 trillion in additional Green Capex without stretching balance sheets while still retaining 30%+ of operating cash flow.” The impact of rising interest rates is nuanced. For an announced project already underway and financed, corporates will likely have visibility on cost of debt for the coming 3-5 years; preparation for this spend is no doubt partly behind the reduction of short-term borrowing in Europe from 30% to 20%. Long-term lending (over 5-years maturity) is holding up well – it picked up slightly in August and is still above the pre-pandemic average growth rate. The broad observation is that although the bond market has repriced up sharply, banks have been happy to step in and so the true price shock for corporate borrowing is more moderate than bond yields suggest. Governments are clearly also stepping in with tax benefits and other incentives which reduces the bill that corporates will foot and shortens the payback on the spend they do.
We certainly don’t expect there to be no cuts, and indeed some have already emerged. Semiconductor company Micron recently cut its 2023 capex guidance by 30%, or $8 billion. Putting this in context, TSMC alone is still expected to spend $37 billion in each of the next 2 years and most of the semi capex cuts have so far been in memory, which was anticipated by many industry analysts given pricing trends there (logic and foundry are expected to be more resilient).

The long-term requirements for investment are relatively well-established by now, but we detect nervousness among investors about how a combination of tightening financial conditions, demand weakness, inflation and earnings forecast reductions will feed into an ‘air pocket’ and capex cuts during 2023 and 2024. We expect this is conditioned by the experience of the previous cycle, but the evidence is currently incontrovertible that we’ve entered a different regime. Many companies can’t afford not to invest today. Cleansing capitalism’s karma – or fixing the ‘sins’ of the last cycle – suggests casting off the ‘lower for longer’ playbook of 2010-2020 and instead looking to the 1970s for inspiration. Then, as now, inflation was the ‘disease’ and investing in the cure – the capex winners – was a profitable strategy.
&nbsp;
[1] Rio Tinto 2022 Interims earnings call, 27 July 2022.
[2] We introduced these ideas in our Q1 2021 investor letter.
[3] According to surveys, the key factors limiting Eurozone production currently are equipment followed by labour; until 2021 this was demand.
[4] Source: Thunder Said Energy
[5] Of which one-third was transmission, two-thirds distribution
[6] Thunder Said estimates $1 trillion annual spend by 2045 assuming wind and solar at just 20-25% of all global energy in 2050. 'Aggressive' renewables scenarios can require $2-3 trillion p.a. of power grid spending.

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