While the world eyes Washington for the latest pronouncements from Donald Trump, the UK stock market has been quietly coming up on the rails. The
FTSE 100 made it to a succession of record highs this week, finally breaking out of a sideways track stretching back to last May.
It is, of course, largely because the focus has been on the US that the FTSE has made this recent progress. Enthusiasm over the Trump presidency and declining expectations of US interest rate cuts have seen the pound adding to its recent losses against the dollar1. That’s a boon for the FTSE 100’s overseas earners, which now dominate the Index.
That’s not the only reason though. A series of weak economic data releases – including a small rise in unemployment rate – have bolstered hopes the Bank of England will cut interest rates further. Rate cuts would stand to benefit both shares and the recently beleaguered gilts market.
UK still offers value
The FTSE 100 may have reached new highs this week, but it still has some way to go to catch up with overseas markets. While investors fret about the valuation of the US stock market, the UK could hardly be more different. Ever since the Brexit vote of 2016, UK shares have been out of favour with international investors as well as investors closer to home.
The defensive qualities of UK blue chips were largely shunned again last year in a world preoccupied with the progress of AI-fuelled tech stocks in the US. UK shares still trade on just 12.7 times forward earnings estimates, compared with around 23 times for world markets. They also offer an attractive dividend yield of 3.8%, easily surpassing world stocks2. Taking share buybacks into account – which ran at high levels in 2024 – UK companies are returning even more to shareholders.
These valuations persist despite a rise in M&A activity involving private equity firms and other foreign businesses last year suggesting the value of UK companies is starting to be recognised. According to data compiled by Bloomberg, mergers and acquisitions worth around $177 billion were announced in the UK last year, compared with $99 billion in 20233.
It’s important to remember, however, that markets can remain cheap for extended periods requiring patience from investors, a matter noted by Tom Stevenson in Fidelity’s latest Outlook:
“It is easy to make the case for investing in the UK market, but harder to see what the catalyst might be to make it pay. As was the case for many years with Japanese equities, UK shares’ ability to stay cheap might outlast investors’ patience. When the penny dropped in Japan, however, the returns were worth waiting for. The same could happen here” he says.
Boost from the US
With the advent of Donald Trump’s presidency, the focus will surely turn to the UK’s future trading relationship with the US. In Fidelity’s latest Investment Outlook, Investment Director Tom Stevenson draws encouragement from the potential for a boost from the other side of the pond:
“The FTSE 100 has a big exposure to the US (29% of revenues, versus just 22% in the UK itself) and that could be a positive this year as Trump 2.0 gets into full swing” he says.
The risk is that the UK has a very open economy, so would be exposed to a general downshift in global trade as a result of tariffs. On balance though, the UK appears to stand in a good place to benefit from any US growth boom.
More broadly, one effect of the low rating currently being applied to the UK stock market is that investors are being presented with an opportunity to gain an exposure to world markets at a discount.
UK growth expected to bounce back
Concerns about the near-term growth outlook for the UK have been compounded by data showing the economy failed to grow in real terms (adjusted for inflation) in the three months to November4. An increase in employers’ national insurance contributions announced in the Budget hasn’t helped sentiment either.
Importantly though, the Budget contained plans to increase public spending. The start of this, coupled with robust wage rises for public sector workers, should help to lift growth. Data out this week showed wages rising by 5.6% in the three months to November5. That represents another real terms increase in living standards.
The Bank of England expects the economy to grow by a respectable 1.5% this year, faster than in 2024. That broadly agrees with the latest from the IMF, which said earlier this month it now expects the UK economy to grow by 1.6% this year followed by 1.5% in 20266.
Interest rates forecast to fall
Inflation has blipped back up to 2.5%, having fallen to 1.7% in September7. That’s a far cry from the rates we saw in 2022 and 2023 but it’s still above the Bank of England’s 2.0% target. Markets anticipate that this will not be a barrier to lower interest rates though, given that the Bank sees inflation falling back to target over the medium term.
In the Bank’s Monetary Policy Report in November, the Bank Rate (currently 4.75%) was seen falling to about 3.7% this year8. Other forecasters are divided on how far rates can fall, given the opposing forces exerted by a Budget that was seen as inflationary and signs of a cooling economy.
UK fund ideas
Deciding where best to invest in the UK can be a challenge, given the vast array of funds,
ETFs currently available. Fidelity’s Select 50 contains a manageable list of five favourite UK funds, each designed to produce growth or an income or a combination of the two. It encompasses both actively managed and tracker portfolios.
The prospect of lower interest rates should add to the relative appeal of shares paying sizeable dividends. One of the big challenges for income investors this year may be how to replace lost income from savings accounts as rates fall. Investing in shares provides one answer and, while switching from the one to the other entails accepting risks to capital, this also offers the possibility of exchanging a falling income for one that rises over time.
The FTF Martin Currie UK Equity Income Fund is one of three actively managed UK funds on the Select 50 list. Managed by Ben Russon, Will Bradwell and Joanne Rands out of Leeds, this fund aims to generate a higher income than the FTSE All-Share Index plus investment growth over a three to five year period after fees and costs.
The fund pays a quarterly dividend and currently yields approximately 4.7%, an amount that is not guaranteed. Among the fund’s 49 investments are holdings in some of the UK’s largest dividend payers, including Unilever, Shell and AstraZeneca, as well as some mid-cap companies such as Cranswick and IG Group9.
The Fidelity Special Situations Fund, run by Alex Wright, takes a contrarian approach and focuses on underappreciated companies. Owing to this, it offers an exposure to companies often not covered by other popular UK funds.
Currently consisting of 125 holdings, the fund’s largest exposure is to financials, led by holdings in Standard Chartered and AIB Group (Allied Irish Banks). Some defensive stocks are also considered to be good value and Imperial Brands has now become the largest holding.
The iShares Core FTSE 100 UCITS ETF is one of two passive UK funds on the Select 50. It holds the individual constituents of the FTSE 100 in the correct amounts to track the index. Fidelity’s experts note that BlackRock is a seasoned investor in passive funds and that this fund’s cost are low. As such, it may suit cost-conscious investors with a longer time horizon.
Source:
1 Bloomberg, 21.01.25
2 MSCI, 31.12.24
3 Bloomberg, 20.12.24
4 ONS, 16.01.25
5 ONS, 21.01.25
6 Bank of England and IMF, 17.01.25
7 ONS, 15.01.25
8 Bank of England, November 2024
9 Franklin Templeton, 31.12.24
