Article last updated 22 July 2025.
Sanjiv Tumkur, Head of Equity Research, Rathbones
The FTSE All-Share has underperformed other major developed markets so far in 2018, extending a pattern that has been in place since the June 2016 vote to leave the EU. In fact, the UK stock market has returned much less than other global equities going back to 2011.
This long winter for British stocks was due to a number of factors: the UK’s high exposure to sectors such as banking, oil and mining which have experienced periods of challenging trading; a relative lack of exposure to higher-growth areas such as technology; and more recently concerns about the potential for Brexit to impact the UK economy.
While things like a bad Brexit or a global downturn driven by rumblings of a trade war between the US and China might threaten to derail UK equities, we believe they are an attractive investment on a number of metrics. As we write, prices are implying that investors expect a particularly negative Brexit scenario.
Earlier this year the Bank of England changed its forecast for interest-rate changes, and now expects to start hiking interest rates faster and higher than before. This would be to combat stubbornly high inflation, while growth in the economy is also decelerating less sharply than previously expected. Still, it is true that the UK economy has been lagging the rest of its peers in the major developed economies — it grew at 1.7% in 2017, compared to a 2.9% pace in the US and 2.7% in the eurozone, the perennial laggard of the past. More forward-looking indicators of growth, like purchasing managers' indices of business activity, have also been suggesting a slower pace of growth in the UK compared to the US and Europe.
There is little doubt that Brexit uncertainty is having a negative impact on UK growth, making businesses more cautious about investing and expanding in the UK. But we think UK shares could offer fundamental value and an opportunity in all but the most pessimistic of deal outcomes.
On the day of the EU referendum, 23 June 2016, the closing price of the FTSE 100 was 15.8 times the expected earnings for the index over the next year (a ‘forward price/earnings’ or ‘PE’ of 15.8), compared with the S&P 500’s forward PE of 16.8. Since then, despite good growth in the FTSE 100’s earnings, its forward PE has fallen to 13.4. The S&P 500’s forward PE has meanwhile been fairly steady at 16.2, especially as technology giants like Amazon have prospered. This has widened the discount that UK shares trade on to 17%.
Another good valuation measure is what is called projected free cash flow yield, which takes the amount of cash flow a business produces for its shareholders and divides it by the value of its shares. On this measure, the FTSE 100 has also become more attractive — rising from 4.8% at the time of the referendum to 6.5% today. The S&P 500's free cash flow yield was 5.1% at the time of the referendum, making it more alluring on this measure. It was at 5.5% at the time of writing, which is almost a fifth lower than the FTSE 100.
Even if we adjust for the S&P 500’s skew towards faster-growth and higher-valued technology shares, the FTSE 100 still looks relatively cheap. And this is true across sectors: in personal care and household goods, UK-listed Unilever was trading on a forward PE of 18.7 versus US peer Colgate-Palmolive on 22.2, and British energy giant Royal Dutch Shell was on 13.7 compared with 16.5 for American rival ExxonMobil.
The UK was already less expensive on some measures prior to the referendum, and has now become even cheaper to reflect uncertainty over Brexit. Overseas investors may also be put off by the prospect of a hard-left Labour UK government led by Jeremy Corbyn.
If the UK exits the EU with no free-trade deal and there is a hit to trade and to economic growth overall, we think sterling would fall significantly. The FTSE 100 derives approximately 76% of its revenue (according to estimates by FTSE Russell) from outside the UK, so depreciation of sterling would boost the value of these foreign earnings when they are converted to sterling. This would, therefore, push up their sterling share prices.
The FTSE 100 looks cheap — but it is only attractive if we can be fairly sure its long-term investment returns will be good. Our research suggests that the pound is significantly undervalued versus other currencies, and we expect that over the long term it will normalise, which should boost long-term returns to global investors from sterling-denominated equities — although in the shorter term the currency could fall significantly, as we discussed above. So it is probably wise for any investors looking to buy UK stocks to ensure they are buying for the better part of a decade, rather than as a short-term punt.
The FTSE 100 should also deliver decent long-term earnings growth. Significant weightings to energy, mining and consumer staples give it the best exposure among Western markets to higher-growth regions of the world, chiefly Asian emerging markets.
Even though the domestic economic outlook is currently uncertain, we continue to see UK equities, and in particular the more outward-looking FTSE 100 index, as a reasonably attractive investment.
We think the remainder of 2018 will be as bumpy as the past few months. But we are optimistic about the state of the world economy and therefore the growth prospects for quality UK firms with an international revenue base, in all but the worst-case scenario for Brexit. Solid, reliable growth should attract investors in the long run, regardless of Brexit outcomes.
