HSBC Updates UK Sector Ratings: Increases Telecoms and Real Estate, Lowers Energy

Analysts at HSBC released a note on Wednesday updating their sector ratings in the UK, indicating a more cautious approach amid an uncertain macroeconomic environment.

The analysts observed a pivot toward defensive sectors in response to diminishing earnings prospects and apprehensions regarding declining economic growth.

The UK market, particularly the domestically focused FTSE 250, has surprisingly outperformed other European indices during the third quarter of 2024, despite the prevailing economic challenges.

Falling interest rates and a political renewal following the Labour Party’s substantial election victory have improved investor sentiment. However, the economic backdrop remains fraught with risks.

Recent data shows stagnation in GDP growth, a significant drop in business and consumer confidence, and ongoing inflationary pressures within the service sector, as highlighted by the latest consumer survey.

In spite of these hurdles, UK equities have drawn interest from global investors. HSBC’s strategy emphasizes the attractiveness of defensive sectors, given the continuing decline in earnings growth.

The earnings-per-share growth outlook for the FTSE 350 has steadily weakened over the past year, with particularly sharp declines noted in recent months. This situation prompted HSBC to reassess its sector weightings, adopting a more cautious approach as the UK economy faces mixed signals.

HSBC has upgraded the Telecoms sector from “neutral” to “overweight,” citing improved earnings momentum that aligns with its broader European sector strategy. The analysts noted that Telecoms has outperformed the FTSE 350 by 10% so far in 2024, bolstered by stronger demand for defensive stocks during market volatility. Although it comprises only 1.3% of the FTSE 350 index, Telecoms is now seen as a significant growth opportunity.

Additionally, the Real Estate sector received an upgrade from “underweight” to “overweight.” HSBC anticipates recovery as the global rate-cut cycle accelerates. With UK-focused investment funds already positioned with optimism, the bank expects that declining interest rates will further spur gains. While Real Estate underperformed in 2022 and saw only modest improvements in 2023, the upgrade signals increasing confidence that the sector will benefit from lower debt costs and government housing initiatives.

Consumer Products and Services also moved from “underweight” to “overweight.” Despite a sluggish start to the year, the sector has topped the FTSE 350 by 8% in the third quarter of 2024. HSBC’s positive outlook is buoyed by improving earnings forecasts, especially for housebuilding firms anticipated to gain from reduced borrowing costs and increased governmental focus on housing development. Although the sector’s year-to-date performance is slightly negative compared to the broader market, recent trends indicate a more optimistic trajectory ahead.

Conversely, HSBC has adopted a cautious outlook for cyclical, commodity-driven sectors. The Basic Resources sector was downgraded from “overweight” to “underweight,” as dropping commodity prices, particularly in iron ore and oil, have begun to negatively impact earnings expectations. This sector has underperformed the FTSE 350 by 19% so far in 2024, making it the worst performer with a weighting exceeding 1% in the index. Despite some upward adjustments in earnings estimates, significant downside risk persists if commodity prices continue downward.

Similarly, the Chemicals sector was downgraded from “overweight” to “neutral.” While accounting for less than 0.5% of the FTSE 350, this sector has faced a tumultuous year, lagging behind the broader index by 25% in 2024. With its minimal weighting and absence of immediate growth catalysts, HSBC has chosen to adopt a neutral stance.

The Energy sector underwent a more pronounced downgrade, shifting to “underweight” from “neutral.” Analysts described this sector as being trapped in a “value trap,” marked by poor short-term dynamics and fragile sentiment. A 15% decline in crude oil prices during the third quarter of 2024 has worsened the sector’s already poor performance, which is down 12% in the same period. HSBC recognizes that the sector’s fortunes are closely linked to future oil price movements, and without a rebound in crude prices, the outlook appears grim.

Despite the recent positive shift in UK market performance, especially within the FTSE 250, HSBC alerts investors to ongoing challenges. EPS growth projections for 2024 and 2025 continue to weaken, and while UK equities remain attractively valued compared to historical averages, the risk of a sharper economic slowdown remains high. As macroeconomic volatility prevails, defensive sectors are likely to take the lead as investors seek refuge.