UK stocks may finally be back in fashion

By Lucy Raitano

LONDON (Reuters) -London's FTSE-100 hit a record high on Tuesday, raising hopes that Britain's stock market might finally be shaking off years of underperformance as investors look for bargains and UK growth picks up.

Months after rival indexes across the world started chalking up records, Britain's benchmark stock index touched a new peak of 8,076.52, surpassing its previous high from February 2023.

The new peak brings this year's gains for the FTSE 100 to 4% - still behind the 6% rise in the pan-European STOXX 600, as well as France's CAC 40 and Germany's DAX, which are up 7.5% and 7.8% respectively.

The FTSE-100 has long underperformed - whether because of the uncertainty surrounding Britain's economy since its 2016 vote to leave the European Union or because of its perceived shortcomings compared with rival indexes.

Heavily weighted towards basic resources stocks, the FTSE-100 has not benefited from the AI-mania that has lifted U.S. markets, nor from the surge in luxury stocks. Nor could it tap in to the boom in anti-obesity drugs that has made Denmark's Novo Nordisk one of the world's most valuable companies.

But some of these drivers for foreign markets have started to wane, just as rising commodity prices, a weaker pound, a pick-up in UK growth - and lowly valuations - are tempting some investors back to London-listed equities.

"The UK has been cheap for a while, it's cheap relative to history, it's cheap relative to global markets, particularly cheap against the U.S.," said David Cumming, head of UK Equities at Newton Investment Management, who also said the FTSE-100's record high could mark a new dawn rather than a short-term blip.

"The catalyst would be the economic data in the UK is getting better, we are returning to growth," said Cumming.

The London market has a price/earnings ratio of less than 11, compared with 13 for the STOXX 600 and 20 for the S&P 500, trading near its largest discount on record, based on LSEG Datastream data.

The view of the UK stock market as undervalued has contributed to a dip in new listings in London, and spurred a political push to boost the market, including talk of getting pension schemes to up their exposure to UK stocks and plans for a new "UK ISA" tax-free savings product for retail investors.

MORE THAN JUST CHEAP

"The FTSE 100 has recently benefited from the broadening of the rally out of Big Tech, pick-up in commodities and a more diversified sector composition. A weaker pound has been an additional tailwind," said Barclays head of European equity strategy Emmanuel Cau.

The pound is down around 2.2% against the dollar this year, boosting some of the profits FTSE-100 companies make abroad.

Barclays estimates that about 75% of the revenues of FTSE-100 companies are generated overseas.

Higher energy prices are adding to the positive mood for the resources-heavy FTSE-100, with oil prices up 13% this year.

Meanwhile, traders are betting the Bank of England will cut interest rates slightly more aggressively than the U.S. Federal Reserve in 2024, with around 50 basis points of UK cuts priced in for this year as of Tuesday, versus 40 in the U.S.

Lower interest rates tend to boost the appeal of higher yielding assets, such as equities.

"We are also seeing signs of life in the UK economy, with a recent pick-up in activity indicators like PMI, consumer sentiment," said Barclay's Cau.

UK businesses recorded their fastest growth in activity in nearly a year this month, suggesting a rebound from 2023's shallow recession is bigger than economists had been expecting.

Zooming in, top quality UK stocks are coming back into focus, according to Kathleen Brooks, research director at XTB who in a recent note pointed to engine maker Rolls-Royce's 40% rise this year.

"Thus, while it has been easy to dismiss the FTSE 100 as U.S. tech giants steal all of the glory, some UK companies have made an astounding comeback," Brooks said.

Other top performers include mining giant Glencore which is up about 24% in the last two months alone, while banks NatWest and Barclays are up 30% and 25% this year, respectively.

A flurry of mergers and acquisitions is also lifting UK equities, particularly among medium-sized companies.

On Monday, Hipgnosis Songs Fund shares soared as much as 20% after Blackstone proposed to buy it, outbidding Apollo-backed Concord.

Last week, U.S.-based International Paper agreed to an all-share deal to buy UK-listed DS Smith for 5.8 billion pounds ($7.2 billion), edging out a bid by Mondi.

"There has been a pick-up in M&A in the UK ... which highlights the fact that valuations are quite low," said Newton's Cumming.

(Editing by Amanda Cooper and Mark Potter)