(Bloomberg) -- UK stock bulls await vindication in 2025 as an enticing discount and large shareholder payouts are set to lift the market.
The FTSE 100 has managed a decent 6% gain this year, though it still lagged the Euro Stoxx 50 and the S&P 500. And while 2025 is rife with uncertainties — like a threat of trade wars under Donald Trump, the return of inflation pressures and potentially fewer rate cuts in the US — such developments may further boost the relative allure of UK companies, which are focused more on defensive sectors and the service economy.
“I’m more bullish now than I’ve been the last 30 years of my career,” said Gervais Williams, manager of the Diverse Income Trust at Premier Miton Investors. “The main background is of course that the UK is standing on a low valuation” relative to peers, he said.
Williams said UK corporates generate a lot of cash surplus and if things get tricky in 2025, they could prove more resilient than the rest of the market. He sees global investors starting to adopt income strategies, such as via dividend payers, and the UK market stands to be a beneficiary.
The FTSE 100 has one of the largest dividend yields among developed markets, standing at about 4%, compared with 3.3% for the Euro Stoxx 50 and 1.4% for the S&P 500. The benchmark shows an attractive free cash flow yield of about 7.2%, twice as high as the MSCI World.
Financials — which account for 21% of the benchmark — were among the best performers this year. Natwest Group Plc, Standard Chartered Plc and Barclays Plc jumped between 50% and 84% in 2024. Meanwhile, engine-maker Rolls Royce Holdings Plc and British Airways owner International Consolidated Airlines Group SA nearly doubled. And buybacks programs have been another tailwind for many stocks.
Over the past two years, 45% of FTSE 350 members have bought back their own shares, according to Henry Dixon, portfolio manager on the UK discretionary equities team at Man Group. He cited examples such as NatWest and and Imperial Brands Plc, which have seen their shares advance this year by about 80% and 40%, respectively.
“By redirecting cash flows to repurchase shares, companies are capitalizing on low market valuations to enhance shareholder value and boost earnings per share,” he said.
The UK large cap benchmark generates about 75% of its revenue outside the UK, making it sensitive to exports and currency swings. Trump’s return to the White House will increase policy uncertainty throughout the world. But in the event of a global trade war, the UK market could be a relative haven since it’s more geared toward trade in services, rather than goods, where no tariffs are expected.
“There are large-cap UK stocks with significant US exposure, but most both produce and sell in the US and they should gain from the stronger US economy and dollar,” according to Goldman Sachs Group Inc. strategists led by Sharon Bell.
UK stocks’ defensive nature, with 30% exposure to staples and health care, typically becomes an asset when things get shakier on global markets. Also, given the potential for further political upheaval in France and elections in Germany, the UK could become an island of stability with a new government, backed by a strong mandate.
While 2024 hasn’t been bad for returns, the UK stock market has continued to suffer outflows, as well as a relentless de-equitization due to mergers, a lack of IPOs along with the willingness of corporates to relocate to the US. Extremely low valuations have been responsible for this trend, with UK large caps trading at a 40% discount to global peers.
“A lack of allocation to UK equities by long-term domestic capital — pensions/insurance funds — and by households is a large reason for the discount,” Goldman’s Bell said. About one-third of the UK equity market is held domestically, compared with over 80% in the mid-1990s, she added.
A lot of investors remain skeptical. The Bank of America Corp. fund manager survey published this week showed global investors remain net 14% underweight in UK equities, the worst reading since April. Furthermore, the 7% earnings growth for UK firms expected by the consensus relies on a decent margin expansion, given revenue is seen growing 1.4% — the least among the main European benchmarks, Bloomberg Intelligence strategists Laurent Douillet and Kaidi Meng said.
Interest rates are another question. As the Bank of England meets on Thursday, chances of cuts are priced out and after stronger-than-expected wage growth and inflation data, investors are in wait-and-see mode.
Bank strategists remain optimistic for next year. The FTSE 100 has more upside in 2025 than other major European benchmarks, according to a Bloomberg survey conducted last week.
“We see the supportive backdrop for UK equities continuing,” said Jupiter Asset Management portfolio managers Adrian Gosden and Chris Morrison. “We think the pace of corporate activity in the form of mergers and acquisitions can maintain a healthy pace. This reflects the low valuations of good companies as well as well as a stable economy and government.”
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