Whichever way you look at it, UK equities look ripe for a rebound. Despite widespread pessimism about the UK economy, its stock market might be in better health than many think.
Several UK stocks were among the top stock picks from DIY investors during August, according to data from Interactive Investor, including Rolls Royce (LON:RR.), Taylor Wimpey (LON:TW.), Legal & General (LON:LGEN) and Lloyds Bank (LON:LLOY).
According to eToro’s latest Retail Investor Beat, the UK is the most attractive regional stock market for British investors, with 36% of the 1,000 surveyed naming it their most attractive global market for long-term returns. This just edged out the US, which 35% said was the most attractive market.
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“Earlier this year, heightened concerns around political instability and macroeconomic uncertainty in the US prompted retail investors to diversify more aggressively into Europe and emerging markets, often scaling back US exposure,” said Lale Akoner, global market strategist at eToro.
“Today the UK equity market appears to be very undervalued relative to its long-run history and other equity markets,” said Ian Lance, manager of Temple Bar Investment Trust.
Why the UK economy is (relatively) healthier than you think
Employment levels are falling, and inflation is running persistently high, coming in at 3.8% during August. On the face of it, it’s hard to make a positive case for the UK economy at this point.
But in relative terms, the UK isn’t doing so badly. The economy grew faster than that of any other G7 nation during the first half of the year.
“GDP estimates for the year are rising,” says Richard Knight, senior portfolio manager, UK equities at Allianz Global Investors. He highlights that, despite the Bank of England keeping the base rate on hold during its September meeting, interest rates are on a downward trend, having fallen by 125 basis points since July 2024.
“The country has digested and dealt with higher interest rates, and they are still coming down, which is really useful,” said Knight.
Knight added that consumer confidence is relatively high. While the index as measured by GfK fell in September to -19, this is higher than it stood one year ago (before Labour’s first Autumn Budget). Three years ago, the index hit its lowest level on record of -49; as Knight highlights, UK consumer confidence is now at roughly the same level it was before the onset of the Covid pandemic.
While the various measures paint a mixed picture, there is also cause for optimism in PMI data. UK services PMI rose to a 10-month high in August, with the seasonally adjusted New Orders Index increasing six points in August, which Tim Moore, economics director at S&P Global Market Intelligence points out is “the largest one-month gain since March 2021”.
And while inflation is close to double the Bank of England's 2% target, it is tracking in line with the Bank's recent forecasts, which see inflation peaking in September before falling back to its target 2% level over the next two years.
There is no doubt that the chancellor, Rachel Reeves, is under pressure to pull a rabbit out of the hat in November’s Autumn Budget. The chancellor needs to find a way to raise taxes and reduce spending, all whilst stimulating growth, and that is the biggest source of uncertainty in the immediate future for the UK economy.
But the doom and gloom narrative that dominates may be slightly overblown, especially once we zoom out and look at the UK in its present context both relative to recent history and the wider world at present.
Which UK stocks and sectors could be set to grow?
It is important to note that the UK economy and the UK’s stock market are not the same thing. Even if you remain pessimistic regarding the former, there is plenty of reason to hope for gains in the latter.
If you ask former chancellor of the exchequer Jeremy Hunt, tech and defence are the sectors that are most likely to keep investors interested in the UK’s stock market.
According to Alan Dobbie, co-manager of the Rathbone Income Fund, 75% of FTSE 100 revenues are derived from overseas, with that number falling to a still-hefty 50% for UK mid-cap stocks.
“The good thing about the UK market is that quite often you get companies that are either 100% domestic or almost all overseas revenue,” said Dobbie. “You can pick and choose; if you want to invest in the UK market, you can express either a positive or a negative view of the UK economy.”
Lance says he currently finds the greatest levels of undervaluation in financials, consumer discretionary, communications and energy.
While UK stocks have outperformed US counterparts for much of this year, that has largely been driven by large-cap stocks. From a valuation perspective, there is still opportunity in UK mid- and small-cap stocks.
“Small and medium-sized companies have significantly lagged the FTSE 100 in recent years, often leaving what we view as sensibly managed, market leading businesses trading at substantial valuation discounts to history,” said Laura Foll, co-portfolio manager of Lowland Investment Company and Law Debenture Corporation. “It is often (although not exclusively) in this area that we are currently finding opportunities.”
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