UK stocks finally in favour after five years of drought

By Samuel Indyk and Patturaja Murugaboopathy

LONDON (Reuters) - British stocks saw their first monthly inflow in five years in November, potentially marking a turning point, as cheap valuations, political stability and the UK's relative immunity to escalating trade tensions lure investors.

According to Lipper data, UK equity funds saw inflows of $779 million in November, their first monthly inflows since October 2020.

In the last few years, the UK's exit from the European Union, along with a chaotic political environment and sluggish economic growth have pushed investors into better-performing areas, such as the U.S. and its mega-cap technology stocks.

But allocations to UK equities from domestic players have been sliding since the late 1990s.

According to data from Peel Hunt, pension funds used to be key investors in UK equities, but only accounted for 4% as of March this year, from 44% in 1998.

"We've had some really difficult years, but it's created a situation where, with these relentless outflows and negativity, you've got a generational opportunity from a valuation perspective," said Simon Murphy, fund manager at Tyndall.

"The UK looks incredibly cheap versus most other major developed markets."

The FTSE 100 trades at a level 11.4 times the total earnings of its components, compared with the U.S. S&P 500 at 22.3 and the pan-European STOXX 600 at 13.2. This ratio has improved from the 2022 low of 8.6, but is well below its 10-year average of 13.

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British stocks have gained about 7% in 2024, below the near-9% gain for Europe's STOXX 600 and a 28% jump for the S&P 500. The domestically focussed FTSE 250 has risen just 7% in 2024.

Over the longer term, British blue-chips have also lagged, rising 15% over the last five years, compared to a 28% gain for the STOXX and 94% rise for the S&P. The FTSE has underperformed the S&P 500 in eight of the last 10 years and the STOXX 600 in seven.

A more settled political environment after Labour's win in July is another catalyst.

Emma Moriarty, portfolio manager at CG Asset Management, believes the new government may be able to attract more investment in UK equities.

"One of the main areas of emphasis in the Chancellor's Mansion House speech was unlocking long-term equity investment in UK markets, particularly in the UK pension industry," Moriarty said. "Which, if effective, would be of a scale that is large enough to create a more permanent bid for UK equities and some much-needed momentum in the asset class."

Britain's relative political stability contrasts with Germany and France, which are facing their own uncertainties.

"The market hates uncertainty and we're through that (in the UK)," said Edward Kennedy, head of bespoke DFM at Marlborough.

"It's not a massive positive tailwind, but it's not as negative as our neighbours, so from a European perspective, the UK could look a more attractive place."

U.S. President-elect Donald Trump's threat of tariffs on goods from Mexico and Canada has already rattled Europe's auto sector, threatening the industry's tight-knit supply chains and raising investor concerns of higher costs.

While the U.S. accounts for around a fifth of UK trade, over two-thirds of British exports there are services not goods. Trump's focus is widely seen to be on imported manufactured products.

"From an arithmetic point of view, Britain is more insulated than most," Tyndall's Murphy said.

"The UK, on a relative basis, ought to be in a decent place but it depends how much Trump follows through on the pre-election rhetoric."

Cheap valuations have also helped drive deal-making in Britain.

"(There) is a serious degree of undervaluation of UK equities versus their overseas peers, especially the US, something that is behind the current wave of takeover approaches," said Eric Burns, deputy fund manager at Sanford DeLand.

M&A involving a UK target totalled $167 billion during the first 11 months of the year, according to LSEG data, with the UK being the third most targeted nation for M&A globally, behind the U.S. and China.

(Reporting by Samuel Indyk and Patturaja Murugaboopathy, additional reporting by Anousha Sakoui and Gaurav Dogra; Editing by Amanda Cooper and Christina Fincher)