Whatever your political persuasion, it’s difficult to deny that the UK has endured a particularly turbulent period since its departure from the EU became a realistic prospect. In the 18 years between the 1997 and 2015 general elections, the country had three Prime Ministers and three Chancellors. In just nine years between the general elections in 2015 and 2024, there have been five of the former and seven of the latter.

What’s more, despite hailing from the same party, each recent Conservative Prime Minister had tried to take the country in a different direction to their predecessor. Theresa May attempted to deliver an orderly exit from the EU, before Boris Johnson opted for brinkmanship to ‘get Brexit done’. Johnson also oversaw an expansion of the state and took the tax burden close to a post-war high, before Liz Truss tried to reverse that with aggressive tax cuts. Rishi Sunak and his Chancellor Jeremy Hunt changed direction again just a few months later.

Shunned and unloved

This uncertainty seems to have had real-world consequences. One of the most visible examples has been in the UK stock market. We’ve made the argument before that many investors have shunned UK equities since the Brexit vote, when the era of uncertainty began. UK listed companies saw their valuations decouple from those of companies in other countries around 2016, as measured by share prices relative to expected earnings for the next twelve months, known as the forward PE ratio. This has left them much cheaper than their counterparts in other countries, including the US. The UK stock market’s forward PE ratio is only 11 at the time of writing, compared with 21 for the US.

Simply comparing PE ratios alone is a fairly crude approach. For example, many US listed firms have greater growth potential and are more profitable, justifying higher valuations. However, at the start of 2024, we used a statistical technique to adjust for these fundamental factors and industry composition and we still found a large discount that wasn’t there before 2015. Our findings tallied with surveys of fund managers, which showed a deterioration in sentiment towards UK shares in the second half of the 2010s. In our view, this all suggests that persistent political uncertainty has weighed on the valuations of UK companies since 2016.

More recently, though, there are tentative signs that investors are beginning to view the UK stock market more favourably. Surveys of fund managers in the past few months suggest as much. Perhaps reflecting a realisation of just how cheap UK companies have become relative to their peers elsewhere, there has been a marked increase in the number of acquisition bids for them this year, especially from foreign buyers and private equity funds.

The benefit of stability

What could drive a further improvement in sentiment towards UK equities? It’s conceivable that greater political stability — both at home and in relations with our largest trading partner — could help. As we’ve just demonstrated, the wedge between the valuations of UK and US equities was far smaller before 2016. Stability could look increasingly attractive in a world where moderate incumbents in Europe are vulnerable and uncertainty surrounding the outcome of the US election is enormous.

To be clear, we shouldn’t expect investors to be won over immediately. There is a long road ahead for the UK to rebuild its reputation for political stability, and there will be big economic challenges along the way. That said, the bar for success is low. The discount on UK equities is still close to its largest on record. We thought that it seemed excessive before the election, and greater political stability, as seems likely now that Labour has won a resounding electoral victory, would only strengthen the case. UK equities may continue to trade at a large discount for a while yet, but eventually, we think there are good reasons to believe the discount will narrow. All else equal, that would be good news for many UK equity investors.

Download pdf