by Sandrine Soubeyran, Director Research & Analytics, FTSE Russell
The UK equity market has suffered from structural underperformance since 2016. We can see this from the cumulative relative performance of the FTSE 100 Index against European and global equities, in local currency terms, beginning as the UK prepared to vote on its exit from the European Union. As can be observed, the large-cap UK market has significantly underperformed over the period, with Brexit uncertainty and the COVID shock two major headwinds during this period.
How did this affect the UK equity market valuation?
The persistent underperformance of the FTSE 100 means that the UK now stands out for its wide valuation differentials with other regions, having cheapened substantially over the last five years. In the next chart, we compare the 12-month forward PE ratio across regions. The UK FTSE 100 multiple is now in line with its 10-year average (13.0 vs 13.5x), in absolute terms, whereas all other regions’ forward PEs stand at sizeable premia to 10-year averages. Similarly, on a relative basis, the FTSE 100 currently retains a sizable discount as shown by the current relative (0.67) versus average relative (0.84) results in the table below.
The value versus growth rotation?
As we examine the causes of the FTSE 100 underperformance, we see that value has underperformed growth stocks since 2017 in the US, UK and Europe, as shown in the chart below. Only recently, since the reflation trade in Q4 2020, has this trend reversed, with value generally outperforming in recent months.
The UK’s industry composition has been the biggest challenge to performance
Dissecting industry performance by looking at the sector-weighted contributions reveals the huge contribution from US technology since 2016. In the UK, the standout contributing industry was basic materials.
UK equity underperformance highlights key sectoral differences
Comparing the industry exposure of the UK market with its European and US counterparts highlights clear differences in composition. The histogram shows that consumer staples, commodity and financials account for nearly 60% of the UK equity market, while in turn, the UK has limited exposure to technology (1%). This contrasts with the US market, where technology is a much more substantial sector, with a 27% exposure. In Europe, industrials, health care and financials make up about half of the FTSE Europe ex UK Index, and like the UK, is also underweight technology, though to a lesser extent.
In conclusion ‒ where does this leave the UK equity market?
Today, the US and UK lead the EPS growth recovery outlook for 2021, and along with Europe, have enjoyed large upgrades in their 12-month EPS estimates. As the rotation into value gets underway, the UK is benefiting from its industry exposure to cyclically sensitive sectors, notably in basic materials (see industry exposure in the chart above).
Central bank GDP upgrades after vaccine rollout success
The latest central bank GDP forecasts highlight differences in growth prospects between countries after the pandemic, with notable upgrades in the US and UK, after successful vaccine rollouts. (China’s forecast was upgraded more modestly but is above 6% after success in resisting a major second wave.)
Success in vaccine rollouts, especially in the UK and US, the re-opening of the economy, and the Biden fiscal stimulus program largely account for recent central bank growth upgrades.
Other valuation metrics also show FTSE 100 undervalued versus other markets
Finally, in addition to positive economic growth prospects, the CAPE ratio (cyclically adjusted price-to-earnings ratio), which helps assess whether a market is undervalued or overvalued, points to the FTSE 100 as being currently below its 10 and 20-year averages. In contrast, the CAPE of other markets are either around historical averages, or well above (notably the US).
This overview draws from a recent webinar where experts from Eurex and FTSE Russell discussed the perspective for UK equities, which also marked a new partnership on FTSE 100 derivatives. Part of the futurization project at Eurex, a leading exchange in dividend derivatives and Total Return Futures (TRF), the partnership taps into the increasing demand from large investors to have listed OTC total return swaps versions.
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