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UK stock market – a change in fortunes on the way?

With the Brexit deal done and the vaccine roll out gaining speed, could the fortunes of unloved UK shares be turning? We share our outlook and what it could mean for investors.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Emma Wall
Head of Investment Analysis

Published on 13 January 2021

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

The UK is an unloved stock market. Over the past year alone, UK investors have taken nearly £10 billion out of UK equity funds – preferring instead to send their money across the pond to the US stock market.

2020 was far from an isolated incident. Looking back over the past five years, funds in the UK Equity Income, UK All Companies and UK Smaller Companies sectors have seen steady monthly outflows with very few exceptions.

So why the fall from favour?

Lots can be blamed on Brexit. Since the referendum to leave the EU in 2016, investors have turned away from UK shares, as the political backdrop created too much market uncertainty. Big banks on Wall Street, charged with investing billions of dollars of company’s money every year skewed their portfolios away from the UK. Retail investors also preferred to look in other areas for investment opportunities.

The US stock market has climbed higher since the EU referendum, hitting record breaking levels again and again. All while the UK market’s limped from one year to the next. Growth stocks, less well represented in the UK compared to the US, have just registered their best ever five year stretch versus value companies in history.

As a result of the political uncertainty and recent market trends, the UK market now looks undervalued versus both history and many global peers.

According to the CAPE ratio – a measure of valuation that’s used to predict future returns, although with no guarantees – the UK market is undervalued. Some of the most depressed sectors globally are energy and banking stocks, sectors that the UK market is rich in. In contrast, the US is thought to be overvalued, and in particular healthcare and tech stocks.

This article isn’t personal advice. If you're not sure if an investment is right for you make sure you ask for advice.

A change of fortunes for the FTSE?

So with the Brexit deal done, could the fortunes of unloved, undervalued, UK shares be turning?

Well, feelings on the economy improved in the final weeks of 2020 – with sterling rallying against most major currencies.

Normally a rise in sterling can have a detrimental impact on the largest UK stocks. The pound is seen as a bell weather for international sentiment on the UK. But with 75% of the FTSE 100 ’s revenues earned outside of the UK, a rise in sterling can mean a drag on company’s income streams.

But strengthening sterling didn’t prove too much of a headwind for UK shares in December. Good news helped push the market up, even outperforming US shares.

The combination of a Brexit deal and positive vaccine developments meant that the struggling UK stock market at least ended the year on a high. Some are wondering if this could be the beginning of the end of the one-way US growth trade.

More optimistic investors are taking the gains as a sign of what’s to come in 2021, a reversal – finally – of fortunes for these unloved companies.

A recent survey by the Association of Investment Companies showed that some UK equity fund managers consider Brexit to be a turning point for domestic stocks. That’s despite the headwind of lockdown 3.0. Some think it could be a catalyst for flows back to UK shares. The fact that no-deal is also now off the table means the potential for extreme disruption from Brexit is shelved.

But despite the political resolution, there are still clouds on the economic horizon for the UK. Growth uncertainty lingers, as we battle the coronavirus and the associated restrictive lockdowns.

Coronavirus still dominates global market sentiment, and asset prices. While the UK stock market reacted positively to the Christmas Eve Brexit deal, it was the vaccine news of early November that had the biggest positive impact on UK stocks in 2020.

Among the best performing investments in November were those with disappointing records in recent years – like value-biased UK equity income funds. In some cases, it took just two days to make up months of poor performance. But the same can be true of negative virus news, having the power to derail markets and undo gains across the globe.

Remember, investing should be for the long term. That’s not a few months, but instead should be considered over a time horizon of years – ideally five or more.

So what should investors do?

At the very least, the New Year can prove a good opportunity to review your portfolio. That means making sure you’re happy with how much risk you’re taking and that you’re still well-diversified.

Stocks that have done well might now mean you have too much invested in certain regions, sectors or styles. If that’s the case, then it could be worth taking some of these gains and investing them into areas that maybe haven’t done as well. While that might seem counterintuitive, it’ll likely help rebalance your portfolio and not leave you too overweight in any one particular area.

There are some signs of green shoots for home-soil stocks – and from lower valuations than lots of other developed markets. Remember all investments can fall as well as rise in value so you might not get back what you invest. As ever, there are no guarantees with investing.

So if you’re feeling brave, contrarian and optimistic, the UK could offer some undervalued opportunities.

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