Analyzing the Valuation Gap: UK vs US MSCI Index
Recently, the difference in valuations between the UK and US markets has become a focal point for analysis. Below, H Capital founder and financial expert, David Bojan, analyses the valuation gap between the MSCI UK index vs MSCI US index in search of promising signs for UK equities.
The chart below shows the valuation of the Morgan Stanley Capital International (MSCI) UK index relative to the MSCI US index using what is referred to as the 12-month forward price-to-earnings ratio.
This serves to demonstrate the valuation differential between the two markets and in particular the discount that has built up in the UK over the past decade, reaching -51% at the start of this year.
For long periods of time, the UK stock market has naturally traded on lower valuations due to its heavy weighting towards sectors like financials, energy, and mining, unlike the US which holds a large proportion of tech stocks with much higher growth potential.
This gap has been compounded by post-Brexit sluggish economic growth and a rapidly growing US market supported by an AI-driven rally in which the UK market has failed to fully participate in.
The UK not only looks cheap relative to others but also compared with its
own historical standards, trading 10% below its 20-year average forward price to earnings.
Promising Signs for UK Equities: Resilient Earnings and Low Valuations
The extent to which UK equities have fallen out of favour with the wider investment market has created an opportunity for investors to find companies which have been dragged down by poor sentiment rather than underlying fundamentals and are now offering attractive upsides.
A recent increase in interest from private equity firms in the US has also been a promising sign of the tide beginning to turn, contributing to the recent pick up in share prices.
For example, in March, Spirent Communications, a telecommunications company received a bid at a 61% premium to the prior day’s closing price. A subsequent offer from Keysight Technologies at 201.5p per share, 15.1% higher than the initial offer from VIAVI Solutions, sent Spirent’s share price soaring.
Other recent bidding examples include mining giant Anglo American and Hipgnosis Songs Fund, both of which have spiked more than 25% in the last month.
While low valuations by no means guarantee future outperformance and a narrowing in the discount, there are reasons for optimism. Earnings have proven resilient this year, monetary policy is set to begin easing, and in a year of geopolitical uncertainty surrounding elections, the UK’s circumstances look relatively straightforward.
The UK equity investment funds on our preferred investments list (PIL) reflects our conviction in their valuation, with the UK standing out as the cheapest developed market. Following a long period of underperformance, the UK market, particularly the small and mid-cap segments which we lean towards, presents compelling opportunities.
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