Investment Perspectives: The resurgence of the unloved UK stock market

11 Jun 2024

Investment Perspectives: The resurgence of the unloved UK stock market

UK equities have been creating considerable noise in the news recently so what exactly is going on with the UK stock market? On the one hand, the FTSE 100 reached a new all-time high in May and sentiment among market participants appears to be good but on the other, UK equity funds are still unloved and undervalued compared to their global and US peers.

Many world equity indices typically capture large and mid-cap representation across developed countries. Going back around 25 years, the UK market held a strong position of around 10 to 12% of these indices but has been on a slow decline ever since and now has a much weaker representation of around 4%. The UK market has shrunk to such an extent that it can now be completely ignored by investors. 

What’s happened to cause this entrenched downward turn? One notable catalyst is the shift in pension fund allocations. Traditionally, UK pension funds would allocate a significant element to UK stock markets but the Myners review in 2001 encouraged big UK pension funds to adopt more diverse strategies such as increasing global equity exposure and so the largest pension funds began transitioning to broader investing overseas. A staggering £250 billion of assets have been reallocated away from the UK stock market in recent years and this has had a damning effect.

How do global investors see the UK stock market? The Brexit referendum in 2016 caused UK companies to fall in value compared to their global peers, as foreign investors avoided the political instability, and they have never made back the lost ground. The make-up of the UK market has traditionally been concentrated into global banks, major oil companies such as BP and Shell and global mining companies such as Rio Tinto and Glencore. Tech companies with high valuations are a meaningful feature in the US stock market but aren’t particularly prevalent in the UK market. So, the UK market is potentially seen as being in sectors that are unpopular, and this can put the foreign investor off.

What’s the picture with the UK economy? After a mild and short-lived recession at the end of 2023, economic growth has been unexpectedly resilient. The EU withdrawal agreement was passed in early 2020 and had the potential to change the course of investor confidence by finally making the terms of Britain’s withdrawal from the EU clear but the pandemic and ensuing economic consequences soon put a stop to that. Inflation in the UK has been stickier than in the eurozone and the US, and when it comes to growth, the UK has struggled to date compared to other G7 countries.

Against this background, investor confidence has been shaken, leading to UK equities falling out of favour and consistent outflows from the UK equity sector. The Investment Association reported that UK equity outflows in 2023 reached a staggering £13.6 billion. International investors have been turning to growth-oriented sectors like tech stocks and US equities for their returns.

What does the future look like for UK equities? Well, it's not all doom and gloom. The opportunity to buy global companies at low valuations is seriously appealing and takeovers of UK listed companies have been gaining momentum. Our currency is steady, the downward inflation trend continues, and our economy is stabilising, so some overseas investors are taking the opportunity to add quality companies to their portfolios at exciting valuation discounts and don’t forget that many UK businesses operate around the world, so there’s the argument that such investments provide at least some global exposure.

How will the political landscape affect the trajectory of the UK market? Research from Citi shows that the main UK index is likely to grow in the six months following a Labour victory at the forthcoming general election and decline following a Conservative win, but the pound has also crashed five times during previous Labour governments so it’s anyone’s guess how the outcome could affect markets.

The big question is, will the UK market experience a turnaround anytime soon? Equity valuations have been low for many years now yet we’re still waiting for that defining moment. We are seeing green shoots that the re-valuation of the UK market might be on the cards, and the more stable economic backdrop combined with low valuations may force a shift in sentiment. Given that low valuations reduce the risk to the downside, a more neutral stance or positive upgrade to UK equities in your portfolio is worth considering and while we’re all waiting for the UK market to finally recapture the hearts of investors, a robust dividend yield will sweeten the way.

Robin Ghosh, Senior Investment & Research Manager

Katie Sykes, Client Engagement & Marketing Manager

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