It’s no secret that UK stocks have long been overlooked and undervalued for years now. But conditions are changing - and they’re changing quickly.
Even with Trump’s “Liberation Day”, there are currently several underlying macroeconomic and geopolitical factors at play, which suggest UK names are at the beginning of a re-rating, despite the highly volatile backdrop.
But are those factors enough to make UK equities an attractive investment proposition once again this St George’s day - and beyond?
Key Takeaways
- UK pension funds have dramatically reduced their allocations to UK equities over the years. However, recent government rhetoric points towards a meaningful push to increase domestic pension fund investments.
- Increased government spending on defence and infrastructure in the UK and the EU could help provide further long-term support for UK names.
- Risks remain, such as a sustained global trade war, so maintaining an investment approach based on fundamentals is key.
A more supportive backdrop
A primary reason for the extended period of underperformance by UK stocks is the slow but steady retreat of domestic capital. Back in 1997, UK pension funds held 53% of their assets in UK-listed companies. Towards the end of 2024, they held just 4.4%. The mass exodus from UK names has undoubtedly contributed to the depressed valuations we are currently seeing.
However, the UK’s new Pension Minister, Torsten Bell, has signalled a push to increase pension fund allocations to UK stocks. If he is successful, there would be a meaningful boost to the UK market, unlocking much-needed growth. Plus, if even a slight increase in UK pension assets were redirected to domestic stocks, there would be an uplift in liquidity as well as overall confidence in the local market.
Another significant tailwind for the UK market comes from increased infrastructure and defence spending in the UK and EU. Thanks to growing geopolitical tensions, coupled with energy concerns, European governments are ramping up their investments in national security as well as spending state funds to ensure energy independence. Earnings growth will not only have the potential to accelerate in the next few years, but at a pace higher than in the US too.
Against this supportive backdrop, UK stocks themselves are also trading at a substantial discount relative to both historical averages and global peers. The size of some discounts are extreme - and surprising. Many businesses are cheap by any measure, yet have strong fundamentals such as solid balance sheets and attractive dividends.
It should come as no shock that we’re also seeing signs that companies themselves are starting to realise the underlying value of their UK businesses. Share buybacks among UK-listed firms have risen, reflecting balance sheet strength as well as all important management confidence in long-term valuations. Merger and acquisition activity is picking up too, further demonstrating the attractiveness of UK names against their current price.
Trade wars and risk-off sentiment
Worries about Trump’s new 10% tariff on the UK are, of course, understandable. Furthermore, any of the new US tariffs have and will continue to affect many markets with which the UK is closely linked. Alongside the US, the UK is also linked with Emerging Markets and Europe - two regions that will be hurt by Trump’s tariff policy.
However, there is some good news. The domestically-focussed part of the UK market should be protected in part. The UK has a services based economy and exports a much smaller amount of goods than countries such as Germany or Italy. When this economic structure is combined with the defensive tilt of key sectors within UK indices, such as consumer staples, utilities, and healthcare, UK names could provide resilience during periods of weaker global growth or trade disruptions.
Risks do remain, though. A protracted global trade war could further derail any UK market optimism, with a marked shift in investor sentiment to a risk-off stance. Plus, any more future geopolitical shocks or macro surprises could exacerbate the problem as markets are always strongly averse to unknowns and uncertainty, which manifest themselves as heightened volatility.
Square Mile’s view of UK equities
We have been supportive of UK equities for some time now, as we believe that the UK market presents unique opportunities - which still exist, despite current worldwide volatility. In times like this, making knee-jerk reactions can be tempting, but maintaining a long-term perspective is more important than ever. In fact, the market turmoil that followed Trump’s tariff announcements made clear the importance of Square Mile’s long-term, diversified investment approach.
Investing in strong companies for a long time horizon is, we believe, the best way possible to ride out inevitable market fluctuations. Markets will often experience short-term volatility driven by geopolitical and macroeconomic events, which is why it is always crucial to focus on the underlying fundamentals. We also look to invest across a myriad of sectors and asset classes as diversification remains one of our key tools. It reduces exposure to any single risk, so we can help to protect client returns.
As we continue to monitor the evolving market landscape, in both UK companies and further afield, we remain committed to adjusting portfolios if we deem necessary. Doing so helps us navigate both challenges and opportunities when they present themselves.
Happy St George’s Day!
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