Analysis suggests that UK valuations are significantly below historical averages, and coupled with a bullish outlook for sterling appreciation, bold investors may be able to take advantage of this.
“UK equities offer very attractive expected returns for the long-term investors, but it requires the mentality of going against consensus and having a long-term investment horizon,” said Peter Garnry at Saxo Bank.
As it stands, UK equities are at a 10% discount to their historical averages.
According to Garnry’s analysis, they are offering a 9% annualised real rate of return on a long-term horizon due to a meaty 42% valuation discount to global equities.
Assuming a 3% annual inflation rate, the nominal rate of return – that is excluding the corrosive impact of inflation – would be 12%.
In fact, the London Stock Exchange is the cheapest among the developed markets, according to Morgan Stanley.
This has caused the Square Mile considerable harm since the 2021 bubble burst. Especially over IPO-starved brokerages.
But this short-term weakness also brings opportunity if and when volatility subsides.
Then there are the attractive yields from dividends and buybacks, which are averaging 7% for only the third time since 2006.
This all adds up to a pretty bullish outlook on UK equities, but it does rely on a few clunky assumptions.
Will the 10% historical valuation gap close? Will inflation fall back to 3%? Will future cashflows support dividends and buybacks?
That is up for the individual investor to decide.
It all comes back to Brexit
The UK’s substantial discount is directly linked to Brexit, which was “catastrophic” for UK equities, Garnry stated.
He explained that in the period from 2007 until the Brexit referendum in June 2016, UK equities matched global equivalents, helped by London’s tilt towards the financials, energy, and materials sector which typically have a lower equity valuation due to the pro-cyclicality.
“The Brexit referendum in favour of the UK leaving the EU was initially not a shock to the UK equity market, but as investors realised what it would mean for long-term economic activity, inflation, and competitiveness the valuation gap to global equities widened significantly and has only become worser since Brexit.
“Essentially, it is the market’s brutal vote over UK equities as a part of the market that is getting less and less interesting,” said Garnry.
The “political circus” that has been part of the UK society since Brexit has not helped either.
Yet all of this calamity is precisely why the bold global investor should sit up and pay attention, with the only requirement “being a good portion of patience”.