Is it the right time to invest in the UK stock market?

UK stocks are currently cheap compared to their overseas counterparts, but with potential takeover activity on the horizon and growth once again on the horizon, it looks like the situation could be starting to change.

In recent years, the UK market has struggled to keep pace with its competitors and has suffered from a lack of high-quality technology stocks, while US-based companies have seen meteoric gains.

As a result, UK stocks are considerably cheaper than those in the US or Europe, while at the same time offering higher dividends and operating in a faster-growing economy.

Richard Hunter, director of markets at Interactive Investor, said: ‘The FTSE 100 has tended to languish in recent years, largely due to the fallout from Brexit and the index’s relatively low exposure to the technology sector, which has been ‘the’ trade that investors are chasing lately.

‘However, there are some signs that luck may be changing.’

Last month, the Bank of England cut interest rates for the first time in 2024 to 5 percent and is expected to make further cuts before the end of the year.

By comparison, the US has yet to see a rate cut, although this could be in the cards for the Fed’s impending decision.

The UK has also recorded strong growth so far in 2024, with GDP up 0.7 per cent in the first quarter and 0.6 per cent in the second, compared with growth of 0.3 per cent and 0.2 per cent in the eurozone and 0.4 per cent and 0.7 per cent in the US.

“The UK economy is looking set to continue to grow,” said Tom Stevenson, chief investment officer at Fidelity.

In July, the IMF upgraded its growth forecast for the UK in 2024 from 0.5 per cent to 0.7 per cent, although it maintained its forecast that the economy will expand by 1.5 per cent next year.

Meanwhile, Britain’s new Labour government says it has put growth at the heart of its economic agenda.

‘In addition, the UK is now supported by several factors, including stronger growth and the real start of a fall in interest rates.

“That could prompt a further narrowing of the discount that has been applied to UK stocks since the Brexit referendum in 2016.”

While the UK market is increasing in value, Fidelity data shows it remains at a significant discount.

The UK stock market has a price/earnings ratio of 11.7, much lower than the 21.0 in the US and Canada, and the 14.1 in Europe (excluding the UK).

The price/earnings ratio indicates the value of a company’s shares in relation to its earnings.

Companies with low ratios are often considered value stocks.

Stevenson said: ‘The UK stock market is no longer trading in absolute bargain territory, but it is pretty close to it.

‘Valuations in the US – even after the mid-summer market pause – remain near their recent highs.’

With UK stocks still trading at a steep discount to those elsewhere, they are becoming increasingly attractive prospects for potential buyers.

‘Evidence of the attractive market valuation and new political stability comes from the number of foreign acquisitions we have seen so far this year.

“In fact, the value of deals for UK businesses hit its highest level since 2018 earlier this year,” Stevenson said.

Cybersecurity firm Darktrace and packaging firm DS Smith have both received high-profile bids this year, and Rupert Murdoch’s REA Group is now considering a bid for Rightmove.

In addition to this, the Government has pledged to encourage new investment in the UK, both through a £7.3bn national wealth fund, and by considering reducing regulation and scrapping stamp duty to make the UK a more attractive prospect.

Hunter said: “The possibility of attracting pension funds back to the UK in a significant way is another intriguing possibility that would immediately bolster the outlook.”

He added: “Over the long term, the UK remains an investment destination packed with quality, proven names, and while returns may be lower than some other indices, the potential rewards that come from many well-regarded names are evident and may be increasingly coming to the attention of overseas investors looking for an alternative outlet.”