Why the British Stock Market Is Outperforming the U.S.
Over the past three months, the tech-heavy Nasdaq Composite COMP-2.78% and the S&P 500 SPX-1.90% both took a beating. Not so the FTSE 100 UKX-0.15% , which tracks the United Kingdom’s largest publicly traded companies.
It was a good place to invest when the U.S. markets were not. Even better, the U.K.’s outperformance could continue for a while. “It has to do with tech,” says Jack Ablin, chief investment officer at Cresset Capital. The London Stock Exchange LSEG-1.95% has no equivalents to the massive U.S. tech stocks such as Apple AAPL-2.02% , Netflix NFLX-3.68% , or Facebook parent Meta Platforms FB-3.74% . And tech has been the most notable underperforming sector in the U.S.
The U.K. market has a projected earnings yield of 13%, including dividends, over the next year, compared with 7.5% for U.S. large-caps, Ablin says. That means profits and dividends could add almost twice as much investment value in the U.K. If that happens, it will be a continuation of the outperformance of U.K.-listed stocks. In the three months through Feb. 7, the Nasdaq was down 12.2%, while the S&P 500 lost 4.5%. By contrast, the FTSE 100 gained 3.7% over the same period, according to Dow Jones Market Data.
In addition to the lack of tech exposure, the U.K. market’s outperformance reflects outsize weightings in hot sectors: energy, materials, and financials. Those three industry groupings account for 41% of the FTSE index. The same groupings account for a mere 15.9% of the S&P.
Energy stocks got buoyed on the back of rising oil prices. Materials have also been lifted by historically good prices for iron ore, copper, and aluminum. Meanwhile, financials, including banks, have benefited from rising interest rates.
“Higher interest rates are generally good for banks, and investors don’t mind inflation because that improves credit conditions,” Ablin says. Rising prices effectively reduce the real, inflation-adjusted value of loans, making them more affordable for borrowers to repay.
Even those who think tech will bounce back see the U.K. market rallying for a few more months. “The outperformance probably runs through the first half,” says Art Hogan, chief market strategist at National Securities.
The outlook for commodities markets, particularly energy and materials, remains solid as the global economy continues to recover from pandemic-related lockdowns. And financials should do well in line with a growing economy and increased demand for business loans.
The British stock market remains one of the cheapest in the developed world. The MSCI United Kingdom Index, which tracks London-listed mid- and large-caps, has a forward price/earnings ratio of 12, according to recent data from Yardeni Research. That’s far lower than the ratios for the U.S., Europe’s single currency area, and Japan, which had forward P/Es of 19.9, 14.4, and 13.5, respectively.
Investors may want to consider the iShares Currency Hedged MSCI United Kingdom HEWU-0.46% exchange-traded fund, which tracks a basket of British-listed companies. The fund generated total returns of 5.1% and 22.5%, respectively, in the past three months and 12 months.
The portfolio is hedged against moves in the value of the British pound, meaning non-British investors can profit from a rally in the U.K. market even if the pound falls. “For the average investor, removing the currency risk is probably a good thing to do,” Hogan says.
There are risks when making this trade. The energy and materials sectors are notoriously cyclical and have been known to slip into downdrafts with frightening speed. Similarly, the banking sector sees periodic busts. But given projected market conditions, giving these stocks a closer look seems worthwhile.