Why are UK stocks suddenly outperforming US markets?

A resurgent banking sector, rising energy and commodity prices and high yields are driving the FTSE 100 stock rally

The FTSE 100 has climbed a modest 2.5 per cent year-to-date, but that looks relatively good with the S&P down 5 per cent and the Nasdaq falling almost 10 per cent. Photo: Bloomberg

We live in a world of surprises but 2022 has delivered one of the most shocking of all. Global investors are suddenly buying UK shares.

The FTSE 100 is now one of the year’s best-performing global stock markets and analysts reckon there is more to come.

Investors have been shunning the UK stock market for years, with Brexit only one reason.

The FTSE 100 index of top blue-chip stocks was seen as stodgy, old hat, off the pace and, put frankly, boring.

It was top-heavy with dusty old sectors such as banking, which disgraced itself during the financial crisis, and fossil fuel stocks, which everyone assumed would be swept away by the green energy revolution.

Why bother with tired dividend stocks when you could fill your boots with Amazon, Apple, Microsoft, Facebook, Zoom, Peloton and Tesla, and become seriously rich?

Yet, life goes in cycles and suddenly whizzy US tech is out, while UK banks, oil majors, mining companies and insurers are in.

Is this a passing fad or does the UK really have something to offer in these strange and troubled times?

Let’s not get carried away here. The FTSE 100 has only climbed a modest 2.5 per cent year-to-date, but that looks relatively good with the S&P down 5 per cent and the Nasdaq falling almost 10 per cent.

Measured over 12 months, the FTSE 100 is up 17 per cent, which is heady growth after two disappointing and frustrating decades.

The index ended the last millennium on a euphoric high, trading at an all-time high of 6,930 on December 31, 1999, but then it went wrong. Incredibly, it was trading below that level as recently as last May.

At the time of writing, it trades at around 7,650, only 10 per cent higher than it did on that heady millennium eve.

Over the same period, the S&P 500 jumped from 1,469.25 to around 4,600 today, a climb of more than 200 per cent.

Sadly for the UK, this year’s FTSE 100’s revival isn’t down to a sudden upturn in economic performance, says Samuel Leach, director of Samuel & Co Trading.

“The UK is battling against rising inflation and stagnant growth, just like the US and Europe,” he says.

The FTSE 250 index, which is a better measure of UK strength because it tracks medium-sized companies with a domestic focus, is actually down 7.4 per cent, Mr Leach adds.

The FTSE 100 has been given a surprise boost by its outsized financial sector, which makes up a hefty 17.82 per cent of the index.

UK banks have floundered since being bailed out by taxpayers during the financial crisis but they are fighting back as the Bank of England becomes the first major central bank to increase interest rates after the pandemic, raising them in both December and February.

Base rates now stand at 0.5 per cent but another three or four increases are expected over the next year, lifting them to 1.5 per cent.

This will widen the banks’ lending margins — the difference between what they pay savers and charge borrowers, Mr Leach says.

“This boosts the bottom line, hence their share prices have rallied and bought up the index with them,” he adds.

Barclays, HSBC Holdings, Lloyds Banking Group and NatWest are all up more than 40 per cent over 12 months.

The FTSE 100 is also benefiting from rocketing energy prices, which have revived the fortunes of ailing oil and gas companies BP and Shell, whose shares are up more than 50 per cent measured over 12 months.

Raymond Greaves, head of research at finnCap Group, points out the irony, noting that “rising energy prices are also fuelling the country’s cost of living crisis”.

It’s an irony not lost on people in Britain and there have been calls for a “windfall tax” on BP and Shell, which are on course to post profits of £40 billion ($54.3bn) this year.

The FTSE 100 also has hefty exposure to the global mining industry, with the materials sector making up 13.39 per cent of the index, led by names such as Rio Tinto, Anglo American, Glencore and Antofagasta.

Commodity prices have been boosted by short-term bottlenecks and supply shortages, along with resurgent demand as coronavirus lockdowns ease, Mike Owens, global sales trader at Saxo Markets, says.

“Mining stocks will also benefit from talk of a new commodity super cycle,” he says.

Another factor driving the FTSE 100 is that companies listed on the index generate an astonishing three quarters of their profit overseas.

This means they are largely unaffected by the prospects of the British consumer, Mr Owens says.

“Investors wanting greater exposure to the UK should consider the FTSE 250 or UK smaller company funds instead,” he says.

The UK is a direct beneficiary of the US tech downturn as investors seek safe havens instead, Daniela Hathorn, finance analyst at online trading site IG, says.

Investors expect US tech and other growth stocks to suffer as inflation beds in because this will shrink the value of future revenue.

Solid, reliable, dividend-paying stocks with steady cash flows today suddenly look much more appealing, she says.

“They are seen as being undervalued and relatively more attractive,” Ms Hathorn says.

The FTSE 100 remains the best major market for investors seeking dividends and currently yields 3.18 per cent, more than double the S&P 500’s 1.27 per cent yield.

BP and Shell combined have channelled £147bn to shareholders over the past decade, via dividends and share buybacks.

The FTSE 100 isn’t dirt cheap, its current price-to-earnings ratio of 16.53 looks close to fair value, but it’s a lot cheaper than the S&P 500, which traded at about 33 times earnings during the recent bull market but has now fallen back to 26.16.

The question now is whether this UK rebound is merely a blip or is there more to come.

Cheap stocks and high yields make the UK tempting right now, Ian Lance, co-lead of investment company Redwheel’s UK value and income team, says.

“It also has a large weighting to sectors that historically do well as interest rates rise, and tend to outperform in risk-off periods, like they one we’re in now,” he says.

There could be more excitement to come as some of “the vast amount of money allocated to the US [is] switched back to the UK”, Mr Owens says.

The UK is no longer a global stock market “pariah” as the Brexit furore fades, US growth stocks stumble and the pandemic eases, Mark Wright, portfolio manager at Momentum Global Investment Management, says.

“With its relatively low starting valuation, it is the UK equity market’s time to shine,” he says.

Mr Wright flags up opportunities including fund manager Jupiter Asset Management, which now yields more than 7 per cent a year.

“We also rate companies such as food producer Cranswick and Accrol Group, which produces toilet tissue, kitchen towel, facial tissue and biodegradable wet wipes,” he says.

Most investors will prefer to spread the risk with an exchange-traded fund (ETF) and a simple FTSE 100 or FTSE 250 tracker from iShares, Vanguard, Xtrackers or Invesco could do the job nicely.

The big risk facing the UK is that the Bank of England’s aggressive rate rises slow economic growth while failing to contain inflation, Iain Ramsay, chief investment officer at AHR Private Wealth, says.

While you may want to increase your UK exposure, don’t overdo it, Mr Ramsey says. “The UK accounts for just 3 per cent of the world economy, your portfolio allocation should reflect this.”