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UK shares are cheap but not necessarily a good buy

Tom Stevenson

Tom Stevenson - Investment Director

This article first appeared in the Telegraph


In this first trading week of life outside the EU investors can move on from fruitless debates about whether Brexit is a good or a bad thing. Investment is about the world as it is, not how you would like it to be, and we are where we are.

I have written here before about the risks of home bias. Many UK-based investors will have a greater exposure to the British economy than they should have. Given that’s the case, today is a good time to assess the domestic situation but also to put it in a broader context.

You would probably not choose to start a life of economic and political independence from here. While December’s election created some political clarity, it has ushered in the best part of a year of significant economic uncertainty. The damage wreaked by the past three and half year’s monomania will not be undone quickly, and 11 months is no time at all to negotiate the kind of wide-ranging trade arrangements we need.

The Bank of England last week poured a bucket of cold water on boosterish talk of a bright new era. Its conclusion that the British economy can grow at only 1.1% without triggering inflationary pressures suggests that the next move on interest rates could easily be higher not lower - and for all the wrong reasons. Mark Carney’s ‘good enough’ scorecard was a tepid assessment of the UK’s health.

In part this downgrade of expectations reflects Britain’s woeful record on productivity growth over the past ten years. This is by no means all Brexit-related, but the absence of business investment over the past three years undoubtedly contributed.

Real wages always follow productivity, so our inability to squeeze more out of our physical and human capital has created a decade of stagnation in inflation-adjusted household incomes. The Government is right to focus on ‘levelling up’ the UK economy - Brexit was a great deal more about inequality of opportunity than it was about Europe, a convenient scapegoat that few people had given a great deal of thought to before 2016.

The starting point for our brave new world is not encouraging. The most recent GDP data for periods ending in November showed almost no growth at all over the very short term and only a very weak expansion on a medium-term view. Given the very poor retail sales data in December, it is likely that the final quarter of 2019 will end up showing negative growth, with only the better-than-expected recent survey data promising to fend off a technical recession over the two quarters either side of the New Year.

Looking into 2020, much hangs on the Government’s willingness to crank up public spending and next month’s Budget will provide a down-payment on this anticipated fiscal stimulus. What is much less certain than Sajid Javid’s desire to open the spending taps is the preparedness of international investors to fund his largesse. We are dependent, as the outgoing Bank Governor famously put it, on the kindness of strangers.

So, no-one is making a strong case for investing in domestically-focused UK shares on the back of accelerating growth. The argument for backing home-grown shares is instead focused on valuations.

After years as a relative pariah as far as overseas investors are concerned, the London market is undoubtedly cheap. The harder question to answer is whether it is too cheap.

In relative terms, the answer is both yes and no. Compared with the US, which has seen the average multiple of earnings on which Wall Street trades rise steadily over the past decade, the UK has persistently lagged. Shares are no more expensive measured against profits than they were 10 years ago. Unfortunately, the same can also be said of both the Japanese and European stock markets. London may be cheap but it is not an obvious outlier in a binary investment world that has split between the US and the rest. The fact that a market is cheap is not a reason to believe that it must become less so in the absence of an obvious catalyst.

For what it is worth, I think the UK should do relatively well, certainly compared with the over-priced US stock market. The time to invest in any asset is when you can’t find anyone with a good word for it. It is hard to remember a time when the London market has been so out of favour.

To come back to the issue of home bias, how much of a factor should the unappealing, if cheap, UK market be in an investor’s decision-making today. How important is Britain’s political transition in the context of all the other factors driving markets at the moment? Not very is the short answer.

The first point, which I can’t make often enough, is that the UK only accounts for about 6% of the total value of all the world’s publicly listed shares. Given that the biggest contributor to global market capitalisation, the US, is rather expensive, there is an argument for bumping up the proportion of your portfolio in the cheaper markets in Asia and Europe, including the UK. Factoring in the international nature of the UK market, you might settle at as much as 15% of your assets in home-grown stocks.

The second point is that how the UK economy fares this year, or whether or not the trade negotiations are a success, will have almost no influence on the value of the other 85% of your holdings. That’s because investors elsewhere are, quite rightly, more focused on whether a soft landing for the global economy facilitates continued growth in company earnings, whether Donald Trump is re-elected after his inevitable acquittal by the Senate, whether the Middle East blows up and when and how China can get on top of the coronavirus outbreak.

Finally, it’s worth bearing in mind that things rarely turn out as badly as we fear or as well as we hope. I fully expect Britain’s life after Brexit to confirm that we tend to muddle through.

Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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