A cheap entry point is an exemplary way to buy or top up a holding in a good company. It’s one reason why markets rebounded so quickly after the recent global sell-off, as investors, reassured that US recession fears were overblown, snapped up shares in tech giants on price dips. Clearly not everyone agrees with hedge fund Elliott Management’s recent verdict that Nvidia is in bubble territory, or at least that the bubble is about to burst any time soon.
Whether it’s a price pullback in surging markets, or a share being shunned because the outlook is poor, low prices, as our cover feature points out, do not always equate to good value. But it is also true that negative sentiment can run away with itself: companies, and the greater market of which they are a part, can be unfairly valued. The UK has been an unloved child among global stock markets as lack of confidence in a nation struggling to find its post-Brexit feet, political upheaval, weak economic growth, stagnant productivity, high inflation, restrictive interest rates and out-of-fashion value offerings have merged to pave the way for low ratings.
The market’s forward price/earnings (PE) ratio has fallen to as low as nine in recent years and is still below its long-term average of around 13. According to Deutsche Bank, of all the main European indices only the FTSE 100 and FTSE 250 trade below their long-term valuations. This year, however, there has been a notable shift, with the FTSE 100 hitting an all-time high in May. Even in the midst of the recent global sell-off, the index did not fall below the 8,000 level.
As some of the factors that drove buyers away fade, investors are being tempted back. First, macro conditions are looking much healthier. Despite the high global exposure of the FTSE 100 and the well-established dictum that the economy is not the market, the right economic backdrop is essential. Inflation is back at target, pretty much. The Bank of England has made its first rate cut after four years of rises, and there are more on the way.
Solid economic growth that is ahead of other G7 nations, rising consumer spending, a steady employment rate and wage growth settling at a lower level than seen in the past few years are positives for business. The EY Item Club expects inflation to stick at around 2 per cent over the next few years, and real household incomes to continue growing at a solid pace. Peel Hunt analyst Kallum Pickering sums it up: rising real incomes and easing financial conditions can be expected to lift consumer demand and encourage business investment.
The caveat here is that it could take time for looser monetary policy to trickle down effectively. But alongside normalisation interest rates will come normalisation in markets.
Political stability has also arrived and this, combined with economic stability, should erode the FTSE 100’s discount. For the next five years the government will be able to get on with the business of running the country uninterrupted and focus on delivering on its promise of economic growth, perhaps repairing relations with Europe, too. BlackRock’s view is that the strong likelihood of a two-term government, which will enable long-term policy implementation, can only brighten sentiment for UK assets.
The US market, trading on an above-average forward earnings ratio of around 20-21, remains a magnetic force, however, sucking in a sea of investor capital. Capital Economics thinks a sustained and substantial rotation out of US equities won’t happen until the tech bubble bursts, and is unlikely before 2026. It forecasts that the S&P will rise to 7,000 by the end of 2025, with the forward PE reaching 25, close to the peak seen in the dotcom era. US companies will also be supported by Federal Reserve rate cuts.
What will really get the UK back on buy lists is evidence of strong growth and rising earnings. Deutsche Bank’s earnings review reveals that while FTSE 100 first-half earnings declined by 7 per cent overall year on year, thanks mostly to contractions in energy and basic materials, 64 per cent of companies surprised to the upside. The bank expects second-half earnings to come in above the consensus, growing by around 10 per cent, while the consensus for full-year earnings for 2025 is a rise of 5 per cent. In fact, the Footsie is Deutsche Bank’s current preferred index in Europe: it rates it as having the best risk-return profile of the European main indices. Deutsche Bank also likes the FTSE 250, and says that as the economy recovers it expects small-cap earnings to reaccelerate and outgrow large-cap earnings.
