How the Iran crisis could affect UK asset prices

0:12David Thorpe: Hello and welcome to the latest edition of the FT Advisor podcast. I'm David Thorpe, Senior Investment Editor at FT Advisor. And today we are discussing the outlook for UK equities after what was a strong 2025 for the asset class. Joining me to discuss the topic are Gervais Williams, Manager of the Premier Might and Multicap Income Fund and other mandates, Gerard Lyons, Chief Economic Strategist at NetWealth, and Charlie Lloyd, Head of Investments at Shackleton. Thank you all for joining me today. If we start with you, Gervais, in your part of the market, to what extent did the weakness of the dollar impact investment returns?

0:55David Thorpe: and is it something that you have to take into account particularly I guess at the larger cap end of the market where you have some holdings?

1:04Gerard Lyons: Yeah I mean the main thing is that markets were good last year you know global markets and the S &P and things were up to something like 15 or 20 percent and what was interesting about the FTSE 100 for example was it was up 30 percent but that's actually in dollar so that's in sterling terms not dollar terms if you take it in dollar terms it was up nearer 40 and i'm talking from the end of 2024 to date so that's just including the part of the early part of this year um so actually the first thing is that actually the uk footsie has done extremely well and it's done even well when you compare it in dollar terms so the dollar had a 10 to 10 effect in terms of your question about individual companies of course i mean the whole point about the footsie is it's dominated by international earners many of them are dollar based and so as the sterling's been strong the dollar's been weak then when you when When you look at them in dollar terms, it looks as though the earnings have actually accelerated.

1:53Gerard Lyons: So from that point of view, the translation effect has helped a little bit. So bottom line is that actually having international earnings has been good news and the FTSE has done extremely well.

2:02David Thorpe: Thank you. Charlie, have you noticed clients at Shackleton asking questions around that? For example, last year, to take it the other way, US equity returns were dented for clients in sterling terms. Was that something that they were highlighting? And when you're thinking about a UK allocation, is that something that you bear in mind as well?

2:28Charlie Lloyd: Well, most of our clients follow the UK market. If you look at most news sources, so BBC News, they'll often quote the FTSE 100. And as we know, it's not a great barometer of global equity returns. So when clients see returns from a multi-asset portfolio dominated by US equities being quite modest versus the FTSE 100, then you get obvious questions because we're off the back of a decade of US equity outperformance. So it certainly prompted more questions, I'd say, from clients. Our job, of course, is to educate and explain to clients that we're managing diversified multi-asset portfolios. As I mentioned to Gervais earlier before we started this podcast, that we do have a UK domestic bias within our strategic asset allocations.

3:17Charlie Lloyd: And I think these days that's perhaps slightly controversial. I think there's a lot of investment houses moving towards this market cap approach. But I think the returns of the UK market in recent years have demonstrated the benefits of having a domestic bias of some sorts.

3:32David Thorpe: Thank you. Gerard, in your role. as an economist. The dollar, as both the previous speakers have mentioned, the dollar was relatively weak compared to sterling last year. That boosted returns. Much more recently, as a result of events in the Middle East, the dollar actually strengthened, actually behaved like a safe haven. But what do you expect next for the greenback and what impact would that have on the UK economy and market? Yeah, well, in terms of your question, I think the start of it is the key issue.

4:10Gervais Williams: Last year, I would say highlighted what I'd call passive diversification away from the dollar. That is, international investors were either putting less of their net new assets into the US. They weren't necessarily selling what they already had in the US, but less of their net new assets were going into the States. Or if they did have a US exposure, they were hedging it more. And so there was a sea change. Now, we fast forward to where we are now. The Iran war has resulted in the dollar being an initial beneficiary. But I think we need to differentiate between the safe haven status and the perceived cyclical benefits have been in the US versus elsewhere.

4:47Gervais Williams: In terms of the safe haven status, I think this is one of the big stories of the time, because we are seeing a significant shift in how people think about safe havens. Now, we've evolved over time. We went far enough back. It used to be the Deutsche Mark and one of the other currencies. More recently, it's been the Swiss franc and gold. But the dollar at various times has come and gone in terms of how it's been perceived as a safe haven. In more recent times, it has been seen as a safe haven. But I do think because of that passive diversification, which is also triggered as much by the unpredictability and uncertainty linked to U.S.

5:26Gervais Williams: policy, political and economic policy. That is all weighing on the states. But in terms of the cyclical bounce as a result of the war, the perception is that the U.S. will be less impacted by the war. But when one works that out, it depends on your perceptions as to how sustained or how prolonged the war will be and how sustained the increase in energy prices will be. But in all likelihood, those could start to unwind quite quickly. So putting it all together, a temporary bounce in terms of the dollar. But I think the underlying story is the one we saw last year. And I think the dollar's role as a safe haven is one of the questionable issues as we go through this year.

6:08Thank you.

6:08David Thorpe: And Gerry, if we stick with you to start us off on the next question as well. Certainly, again, prior to the events of recent weeks, investors in the UK had arguably priced in inflation moving down to target quickly. And that helped certain parts of the UK equity market. But to what extent are the risks to inflation to the upside from here over the next 18 months?

6:36Gervais Williams: Yeah, well, I think we are in a global disinflationary environment. And in terms of the UK, you're right. Ahead of the Iran war, the expectation was that inflation would trend lower, hit the target, indeed, as early as April. The markets were not yet convinced as to how sustained that would be. And that's been reflected in gilt yields. There's a premium in terms of gilt yields, partly the stickiness of UK inflation and partly worries about the fiscal stance in the UK. But when we focus on the inflation component itself, I still think there's a lot of disinflationary pressures globally. And one has to view this in terms of we have a global imbalanced economy, particularly evident in terms of China's huge current account surplus.

7:21Gervais Williams: And trade frictions with the states has led to a diversion of trade from China, effectively pretty cheap exports, high quality exports coming into Western Europe, including the UK. In China, they talk of involution, which is intense competitive pressure. So we still have an element of that, the intense competitive pressure coming into the UK in the disinflation environment. The question that's foremost in people's minds is to what extent the war actually changes that. One of the challenges in the last few years is because central banks have not really kept inflation under control, even though inflation has decelerated in Britain and elsewhere, the cost of living crisis is evident in the sense that the price level is significantly higher than a few years ago.

8:08Gervais Williams: And in terms of markets, we tend not to talk about the price level, but it's very evident amongst the general public. So the point is that inflation expectations are always at risk of spiking higher if there's any sustained increase from higher energy prices feeding through. So that's why there are now upside risks to inflation over the next one, two, three, four, five, six months. And that's why the Bank of England will probably have a key debate as to halt the pace of interest rate cuts in the next few months. But putting it together, yes, there's a temporary pickup of inflation, but it's got to be seen in the context of a disinflationary global environment and in the context of intense competitive pressures that are still likely to feed through.

8:52Gervais Williams: So inflation will be higher than we thought, and that's reflected in market-expected pricing, higher than we thought two, three, four months ago. But that increase in inflation over the next six months might not be sustained because of those other factors.

9:08David Thorpe: Thank you for that. Charlie, certain sectors of the UK equity market, and you mentioned the home bias that you've got, certain sectors have driven the performance, such as, for example, defence companies. but do the conditions exist in your view for market performance to broaden out whether that's into other sectors or further down the market cap scale and is that what's reflected in your in your UK allocations at the moment?

9:36Charlie Lloyd: I think if you'd asked me that question two weeks ago we would have said the environment was very conducive to a broadening out of earnings growth as as Gerry mentioned we were in an environment where inflation was clearly sort of trending lower in the UK. The Bank of England were expected to cut two or three times this year. And of course, that would be pretty positive for smaller companies, companies, domestically focused, consumer facing businesses. But of course, this latest crisis in the Middle East has put that on the back burner, perhaps. Now, clearly, the Bank of England will be a bit more cautious going forward.

10:16Charlie Lloyd: I don't think it's a case of rate cuts being off the table, but perhaps being delayed until perhaps later in the year. And therefore, this sort of recent small cap recovery we've seen in the UK market may be on hold for a period. So again, I think large caps probably preferred over small caps in the very short term. But certainly we've seen in recent months small caps have sprung into life. January was a very good start or good month for small caps generally. I think if we get past this Middle East crisis in the next sort of month or two I think market focus will shift back to that sort of lower inflation, lower interest rates and that broadening out of market returns.

11:00Thank you.

11:01David Thorpe: Gervais I introduced you as the manager of a multi-cap income fund but i think it's fair to say you're you're known in the market for for also running smaller companies funds and you've done that for a very long time and at the moment how do you think about the opportunity set of those large cap dividend payers versus the smaller companies and i remember we we spoke many years ago and used to talk about the opportunity set was sub 10 million and have great stories to tell me about these tiny little companies yeah are they

11:28Gerard Lyons: are they still there they are still there actually what's interesting about the uk market is in contrast to most other global markets is actually this sort of move towards bigness, which has been very much a kind of globalization trend. And it's been very much dominant in the US market, but the biggest market, the biggest companies has actually not been wholly reflected in the UK market. We've still got quite a lot of income shares, which is important, but more importantly, we've also got a very vibrant universe of small and micro cap companies, generally small and micro cap companies. And I think going forward, I think nationalism is going to become important.

11:58Gerard Lyons: we're going to get localism becoming more important, fragmentation of the global markets, uncertainties regarding tariffs and export bans and, of course, conflict and all the rest of it. So coming back to it, actually, the great advantage about many of these smaller companies is one that they are more agile, but more important than that, they're actually able to find opportunities to grow even when the mainstream market aren't doing that well. And so, yes, absolutely. I think the UK market has already started to outperform. I've been well quoted in saying I expect one of the UK market, one of the best performing global markets, including all other markets over the next 20 years.

12:32Gerard Lyons: That's really about income and income growth. Huge urgency for global investors to diversify from capital growth called income. UK happens to be an income market. But most particularly, I think the best performing part of the UK market, even as it outperforms global markets, will be small caps. Their valuations are low, but more importantly, their ability to do deals, their ability to kind of steer around all these kinds of uncertainties going forward means that they can often continue to grow even when the mainstream markets stagnate. So coming back to it, yes, absolutely. I think the UK is superbly positioned right now.

13:04David Thorpe: Thank you. You're doing your job as the UK equity manager on the panel anyway. Charlie, is the UK equity market viewed to some extent as a safe haven in that if there are geopolitical shocks, the oil price goes up, the 100 has a lot of oil companies in it, a lot of defence companies in it. But those stocks that might be considered defensive, maybe consumer staples are also in there, how do you view the valuations of those? Because I guess that's the other thing that one has to think about with defensive equities? Are they expensive defensives?

13:40Charlie Lloyd: Of course. So the UK market historically has delivered lower volatility than US equities and global equities. I wouldn't go as far to say they're a safe haven, but they're a useful portfolio diversifier from a multi-asset perspective. And given the dominance of US equities in global indices, they make up around 70 % of global equities. Clearly, there's this trend to try and diversify away from a market cap-weighted global index. Now, the UK market, yes, there's exposure to sort of healthcare staples, tobacco stocks, but there are also sectors such as banks, materials, energy, which are quite sensitive to economic growth.

14:27Charlie Lloyd: And therefore, I mean, we'd probably call them cyclical value stocks or sectors. So within the UK market, you've got an interesting mix of defensives and sectors exposed to economic growth. But also that factor exposure you get through the UK market, again, is a nice diversifier with US equities, which is obviously dominated by the large US tech stocks. In terms of valuations, I think a lot has been written and said in recent years about the valuation discount of UK equities versus their global counterparts. I think that's fair. There are many reasons for that. But the likes of Astra and GlaxoSmithKline, for example, I believe they traded discounts to their global counterparts, perhaps unfairly.

15:14Charlie Lloyd: But again, we have to remember that in the context of the global equity market, the UK market is quite small, around 3 % of global market cap. And of course, overseas investor flows will start to sort of influence UK valuation. So I think we've seen global investor interest in the UK reignite since that period of dollar weakness we saw at the beginning of last year. And I think a continuation of that will see those valuation discounts start to narrow a bit further. Thank you.

15:51David Thorpe: Gervais, when you're putting together portfolios, do you think about it as defensive encyclicals or predictable learnings versus cyclic learnings? and in that context which of those are maybe cheaper or better value right now yeah i mean

16:06Gerard Lyons: certainly we we like a mix i mean the whole point about portfolios is we don't know the future we may think that the future is set to you know as our sort of current trends will continue but what's happening with nationalism is there's more uncertainty so coming back to assembling portfolios the greatest thing you can put in portfolios is diversity uh you know we've had gold mining companies in our portfolio for the last five years. Well, four years, they did okay. Parles-tu français? Hablas espagnol? Parli italiano? If you've used Babbel, you would. Babbel's conversation-based technique teaches you useful words and phrases to get you speaking quickly about the things you actually talk about in the real world.

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17:46Gerard Lyons: I think very special. Last year, they went up three or five times, right? And nobody knew that the gold price was going to do that, but having that diversity. Currently, you know, with the Iranian war, we've got the odd price going crazy. We've got an awful lot of energy stocks in the portfolio. So coming back to the first point, I think you need genuine diversity, genuine opportunities to kind of not just do OK, but actually prosper through uncertainty as new events come along. But I think the second thing is actually there's an awful lot of companies out there which are just very undervalued.

18:16Gerard Lyons: And so even as their valuations improve, you start to see share price moves. And then as the cost of equity comes down, then they can do deals. We don't know what the future brings. My working assumption is there will be a global recession. We don't quite know whether it's three months or three years. It'll be sometime in that period, probably. And companies which generate surplus cash, mainly UK companies, many small companies as well, will not just survive. They're more resilient, but much, much better. They'll be actually able to acquire assets from the receiver and make disproportionate return.

18:43Gerard Lyons: You know, back in 2023, just a little glimpse of that with HSBC buying Silicon Valley Bank UK for a pound. Probably added five or ten billion to their market cap. Now, that's great. If you start off at$150 billion, as HSBC was at the time, every 3 % or 5 % upgrade is great. But as you move down those market cap ranges to the billion-pound companies, to the 200 million-pound companies, the opportunity for doing not just deals which provide upgrades, but in some cases, the opportunity for some of these companies to do transformational upgrades to generate more surplus cash flow, to generate that earnings growth, which accelerates and exceeds that, and perhaps in international markets like the US, is very attractive.

19:19Gerard Lyons: So I think the UK market isn't just going to outperform because it's a diversifying market or that it's got a better yield than most international markets or that it's cheaper than most international markets. But most particularly, my working assumption is that actually earnings growth from equity income stocks is going to grow to exceed that of growth stocks. And I think that'll catch an awful lot of people unexpected. And that would really drive share prices. And those particularly, to answer your question, specifically UK and particularly UK small caps to be amongst the best performing assets in the world for the next 10 or 20 years.

19:46David Thorpe: Thank you. Gerard, Gervais, as he often does, put in a punchy line there, but there's a global recession coming, whether it's three months or three years. The purpose of this podcast is the UK, and so we'll stick to there. But do you see a downturn in UK economic growth coming from here?

20:06Gervais Williams: Well, just following from what Gervais was saying, clearly one has to look at the UK in a global context. And look, there's different measures of global growth. It doesn't really matter which one you use as long as you use the same one all the time. So let's use the IMF measure. Before the global financial crisis, that was suggesting global growth was around 4.5%. In recent years, global growth has been around 3.1%, 3.2%. And that was generally the expectation for this year. Now, obviously, events in the Middle East add a risk. And there's a stagflationary impact on the global economy and the UK from the Iran war if it persists and if oil prices stay high for a sustained period of time.

20:47Gervais Williams: That is adding to inflation and hitting growth. But when one looks globally, the two major economies that have driven global growth, the US and China, both look relatively resilient. So global growth is probably modest but resilient. Coming back to the UK, clearly the markets seem to think that the UK is more at a risk in terms of stagflation from the Iran war than elsewhere. that's probably a misprice risk. The markets are pricing in the UK being hit harder than it's likely to be. But the way I would describe the UK is 1, 2, 3 and 6. 1 % growth, inflation down to 2%. Interest rates still have the ability to fall to 3%.

21:26Gervais Williams: And unemployment, unfortunately, is 5.2 % at the moment can go up to 6%. But it's probably worth stressing that the spring statement came out as the war was hitting. so in many respects the forecast will be superseded by events but the OBR cut its growth forecast for the UK this year to 1.1 % and talked about trend growth 1.5 to 1.6 % so I think the focus should be on that trend growth 1.5 to 1.6 which is modest not great. Coming back to what Charlie was saying earlier in terms of interest rates the Bank of England's nine-person MPC Monetary Policy Committee is pretty split. Four doves, four hawks, and the governor has been quite balanced at recent meetings.

22:10Gervais Williams: Now, in the last meeting, the one paragraph summarising everyone's position showed that two of the hawks might be coming slightly less hawkish, I wouldn't say dovish. So the market's priced in a rate cut in March and another rate cut later this year. As a result of the war, no rate cuts are priced in. Some people speculating on the hike in March. I think that would be wrong. Clearly, four hawks there. Anything's possible. More likely, rates are left unchanged. But I still think, particularly if the war does not last as long as some people fear, then the previous disinflationary trend will reassert itself, and interest rates can come down as inflationary pressures subside, and unfortunately, as unemployment continues to spike up.

22:58Gervais Williams: The increase in unemployment really highlights the fact that parts of the labour market are still soft. The other parts of the labour market are healthier. We're not yet seeing big inflationary pay increases coming through. But much does depend on inflation expectations in terms of influencing the Bank of England. But putting it together, maybe I should be saying one, two and a half, three and a quarter, six now, but it doesn't sound so catchy, but modest growth, inflation still decelerating and rates can eventually come down. Thank you.

23:31David Thorpe: Charlie, the UK is often regarded as an income market or a dividend market. Would clients of Shackleton that have income as a priority typically end up owning more UK equity than would clients with growth as a priority?

23:46Charlie Lloyd: So our core solutions, as I mentioned, have a UK domestic bias within our income solution. We have a higher UK domestic bias. And that reflects, as we've discussed, the fact that the UK is a yielding market. So in the context of an income multi-asset portfolio, we should have more UK equities in there, as you should have more high-yield bonds and emerging market bonds to deliver that sort of high level of income. So yes, as UK investors or UK-based investors, we're quite happy to be sitting in an equity market, which obviously has delivered capital growth in recent years, but will continue to deliver a yield in excess of global equity markets.

24:33Thank you.

24:34David Thorpe: Gerard, at NetWealth, would the clients who have income as a priority typically have more in the UK?

24:41Gervais Williams: Well, at NetWealth, we have diversified global portfolios. So we look at things in terms of total returns. So we take these factors into account. The appeal of the UK market is there alongside looking at it in the context of a global picture. So the high dividends you get in the UK, plus the factors being touched on that, it's a defensive market in some respects. 50 % of the FTSE is defensive. Another 10 % is aerospace and defense companies. then now the percent is the oil major. So if you're cautious, the UK offers lots of attractions. If you're more upbeat, then the UK is a cyclical market as well.

25:20Gervais Williams: So we would not look at it in the income terms that you describe in terms of the question, but we look at it in total returns. And the performance is pretty robust, actually, both in terms of being resilient in difficult environments and the portfolios that are done well on the upside as well. So we would look at things in a different context of that, but implicitly answer the question in doing that.

25:45David Thorpe: Thank you. Gervais, as mentioned, you run income mandates, but you also run small growth mandates. But with the income funds that you have, how do you think about that balance between dividend yield and total return and trying to ensure some of both?

26:05Gerard Lyons: Yeah, I mean, I think, you know, over the last 30 years, you know, asset markets have done so well, indices have done so well, that actually, there's a natural assumption to just focus on the capital growth aspect of it. Of course, that's entirely wrong. If you look at academic evidence over 50 years and 100 years, your total return is just your income and how much it grows. So if you've got an income of five, and if it grows at 4 % per year, your long term return is going to be 9%. Sometimes evaluations will move up, sometimes they move down, but the net effect is. So actually, the heart of all investment is all about how much cash you generate and how much it grows.

26:37Gerard Lyons: So coming back to the UK market, the whole point about the UK market is it's overlooked and it's standing on a yield which is more attractive, 3.1 % now, which compares perhaps with the world markets. Perhaps if you take the FTSE World Index as 1.7. If you take the Magnificent Seven, which are terrific companies, they've outperformed enormously, they're on a 0.3 % yield. So coming back to it, I mean, fine, but those yields have to go in awfully fast to make cut for the 3.1 you're getting originally. As it is, according to Bloomberg data, the UK dividend is growing at about 9 % per year. Obviously, that's more than usual.

27:10Gerard Lyons: You might only take 3 % or 4%, maybe 5 % as an average. But even if you get 5 % plus the 3 % initial yield, that's a long-term return of 8 % maybe going on for 9%. So that as a starting point is great, especially when inflation is low, as JB says. So that's the first point. The second point is actually the whole point about companies is not just that they're static, but if there's inflationary periods, of course, they get extra growth, not in economic terms, but in nominal terms. And that means that you're protected on that kind of thing. And most particularly, you know, I do fear, unfortunately, that global profit margins, which have doubled since 1985, will go through with nationalism, a period of retrenchment and dividends will come down.

27:48Gerard Lyons: So I think there's going to be a lot of, unfortunately, unhappiness. We're talking about unemployment raising, Jerry's talking about 6%. That's perfectly possible. I think we're going to see a lot of the zombie companies fail, come the next setback, whenever that is. I think there are even some quite highly borrowed companies, private businesses, which will come back. And so I think we're in a period of extreme change. And as I say, the whole point about quoted companies is they're safer, they're less likely to go bust, but more importantly, they continue to retain that employment by buying quite many companies from receivership.

28:14Gerard Lyons: I think actually the whole nature of the political debate will change, really. I think it'll be UK companies, UK capital, UK savings, really, for UK jobs, I think will be bringing home capital in a major, major way going forward. I think that'll boost the valuation of the UK, boost the valuation of small caps. But much more importantly, I think they will actually be socially useful. They'll generate good and growing skilled employment. They'll drive productivity improvement. As the weak and the inefficient fail, that'll drive productivity improvement. Wages exceed inflation. And most particularly, of course, local companies pay local tax.

28:45Gerard Lyons: So I think the whole social usefulness of the market will start to become prominent as well.

28:50David Thorpe: Thank you for that, Gervais Williams, manager of the Premier Maiton Multicap Income Fund and other mandates uh thank you as well to gerard lyons chief economic strategist at netwealth and to charlie lloyd head of investments at shackleton and thank you all for joining me today please do remember to tune in to future editions of the ft advisor podcast thank you

29:25Thank you.