The UK stock market outlook for 2025
There’s little doubt that many UK shares are cheap compared to overseas rivals, but will investors chase them higher over the next 12 months? A number of analysts think so.
27th December 2024 12:24
by Graeme Evans from interactive investor
The threat of global tariffs and a slower pace of earnings recovery means the long-awaited re-rating of the FTSE 100 index is a far from certain prospect in 2025.
The top flight charged to a record 8,474 in the first five months of 2024 before losing momentum on expectations that global interest rates will take longer to fall.
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On 18 December, when the Federal Reserve had dampened Wall Street’s hopes for rate cuts in 2025 to just two, the annual return of the FTSE 100 index had weakened to 5%.
That’s still a robust performance, particularly given that it excludes dividends. But with minimal exposure to the tech sector and some of the UK's “old economy” sectors out of favour, it lags US benchmarks by a considerable distance.
Big falls for heavyweights including BP (LSE:BP.), Diageo (LSE:DGE) and Glencore (LSE:GLEN) didn’t help, with the turnaround of these stocks and other under-pressure companies such as Vodafone Group (LSE:VOD) and AstraZeneca (LSE:AZN) likely to be a key factor in the outturn of the FTSE 100 index in 2025.
An acceleration of 2024’s bid activity may also provide support to valuations in the year ahead, particularly given that strategic and private equity buyers are likely to be attracted by the UK stock market still being at a big discount to its long-run average.
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Approaching the start of the new year, the FTSE 100 index trades on a price/earnings multiple of just over 11 times, well short of the average of 12.8 times since 1987.
Weakness in two of the largest sectors of energy and materials and the double-digit appreciation of the pound, which has weighed on the 75% of revenues generated abroad, have been the chief culprits since autumn 2022.
There are signs that the City thinks the UK will be a robust performer in 2025 after Bank of America recently lifted the region to ‘Market weight’, reflecting a fading drag from energy and the benefit of a more defensive skew. In contrast, it has lowered Germany to Underweight.
Deutsche Bank is also more optimistic on the UK, believing the market boasts the best risk/return profile in Europe. It notes a good balance between cyclical and defensive sectors, which reflects its own sector preferences in the year ahead.
The reduction of political uncertainty since the general election in July, as well as a stronger outlook than the eurozone and fading of the Brexit discount, are other reasons to like UK stocks.
That said, it prefers the UK’s mid-cap benchmark over the FTSE 100 index.
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The FTSE 250 index has risen by more than 4% this year, having also traded in a narrow range since May. It remains well below the record of more than 24,000 set in 2021, whereas a number of leading global benchmarks have recorded all-time highs during this year.
The FTSE 250 overseas sales ratio is closer to 55%, with its status as Europe’s most-domestically aligned major index offering a degree of insulation from currency and trade risks in the wake of Donald Trump’s election.
There’s also potential support from the new UK government after it earmarked over £100 billion, the equivalent to 3.7% of GDP, for capital projects across infrastructure, healthcare, energy and homebuilding over the next five years.
Combined with the Bank of England’s anticipated rate cuts to 3.25% by the end of 2025, UBS believes these policies have the potential to foster an environment ripe for reinvestment and expansion at lower financing costs.
UBS said recently: “In a market where high valuations are increasingly common, the FTSE 250's combination of affordability and growth potential makes it particularly attractive.”
That said, the UK is finishing the year back on recession watch after GDP contracted in both September and October.
Some of this was due to pre-Budget uncertainty, although sentiment since then hasn’t been helped by increases in National Insurance contributions and the National Living Wage.
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UBS economist Dean Turner said: “Yet again, the mood in the UK is seemingly glum, helped in no small part by the long-awaited Budget.
“It would be hard to come up with a Budget that was less growth- and investment-friendly, but that said, the spending that was announced should help the economy grow next year.
“So, deciding not to invest for fears of a recession is likely to be as successful a strategy next year as it was this.”
Many companies have been through their earnings recession and, having cut costs, are now enjoying margin expansion.
But UBS sees the recovery in earnings taking longer after it forecast a further 3% decline in 2024 year before 5% growth in 2025.
The slower pace is partly due to softer commodity prices, disappointing sales to China, and risks to global growth from higher trade tariffs under the new US administration.
UBS forecasts a year-end 8,200 for the FTSE 100, having recently downgraded its stance on UK equities from most preferred to Neutral.
The Swiss bank’s upside scenario shows the FTSE 100 finishing 2025 at 9,800, an outcome dependent on higher commodity prices, better global growth and weaker sterling. Commodity sectors contribute around 25% of FTSE 100 earnings.
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In the most pessimistic scenario warning of a retreat towards 6,600, the bank said that persistently high inflation could keep Bank of England rates higher for longer and put downward pressure on equity valuations and the economic growth outlook.
President-elect Trump is expected to announce tariffs on day one of his administration, sending a shiver through several global economies. The threat of a trade war means Deutsche Bank expects to see some front-running of tariffs, with UK businesses likely to repeat Brexit practices by rebuilding inventories through the year.
The UK economy and stock market have a relatively large focus on services and the financial sector, which should provide some insulation from US tariffs.
Capital Economics, which has a year-end 2025 forecast of 9,000 for the FTSE 100 index, said this was one of the reasons why it thinks that UK equities will perform quite well compared to those elsewhere, even as they fall further behind those in the US.
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