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The British stock bulls have to hold back. The blue-chip FTSE 100 index hit new record highs this week – a year after it did the same and then fell back.
Of course, with most revenue coming from abroad, the index does not reflect general sentiment towards the UK well. Perversely, a lack of technological presence – the source of much of the city’s fears – is now contributing to its performance. The British market is showing further signs of life. But the recent turnaround is still largely due to a strong and persistent valuation discount.
Global investors are coming to terms with the idea of more persistent inflation, longer-term higher interest rates and continued geopolitical tensions, not least in the Middle East. The long-out of favor FTSE offers the best international index to address these fears, as it consists almost entirely of defensive and cyclical sectors. In fact, energy, financials, industrials, materials and healthcare accounted for almost all of the gains over the past three months.
If this change continues, it should also benefit the rest of the UK market. The AI boom that helped chipmaker Nvidia add $1 trillion to its market value in the last six months has stalled. The underwhelming valuations are scaring investors away, causing the U.S. S&P 500 index to fall 5 percent last month.
The UK benefits from this as it is perhaps the ultimate value market in terms of both sectors and sentiment. Compared to the US, the market’s valuation gap is larger than ever and is about half based on forward price-to-earnings ratios.
It’s still best to keep your enthusiasm in check. Outflows from UK equity funds have not yet reversed, continuing a trend that began with the vote to leave the EU in 2016. However, investors are increasing their allocations to global equity funds, an indication that they see opportunities outside of mega-cap stocks. That could be a signal that expanding trading is underway, with less concentration on the biggest stocks, says Citi strategist Beata Manthey. Inflows into the funds of smaller companies (capitalization $5 billion and less) of about $50 billion worldwide this year also support the idea.
There are other potential catalysts to come in the UK: an election, rising buybacks, continued interest from private equity and foreign strategic buyers in beaten-down stocks and promised reforms to pensions and savings. If these start to land, a new high for the FTSE could actually be a sign of better things to come.