UK stocks backed after ‘remarkable’ run

Leading UK stocks continue to boast Europe’s best risk/return profile despite this year’s “remarkable” outperformance by the FTSE 100 index, a top City bank has said.

Deutsche Bank’s Best of British report backs the index to reach 8,700, noting that London’s top flight is still cheap relative to the rest of Europe as well as to the benchmark’s own history.

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It is the latest show of support after Swiss bank UBS recently upgraded its position on UK equities from least preferred to most preferred in its global strategy.

The UK stock market has traded at a steep price/earnings discount to the rest of Europe since the Brexit vote in 2016, reflecting political and economic uncertainties.

However, this discount is fading after recent elections left the UK among those countries with lower political uncertainty while having a similar growth outlook.

According to Deutsche Bank, the “remarkable” 10% outperformance by the FTSE 100 over the Euro Stoxx 50 since April was achieved while having the lowest volatility across Europe.

Other factors driving the bank’s support for the risk/return profile of the FTSE 100 include its preference for many Value sectors, such as staples, utilities and basic materials.

The recent results season showed FTSE 100 earnings declined by 7% year-on-year, mainly due to energy and resources stocks.

However the outturn was slightly better than the second half of 2023 and also showed an aggregate beat to forecasts of 2%, with 64% of the reporting companies ahead of City estimates.

Looking forward, Deutsche Bank expects second half earnings growth of 10% as almost all sectors are due to experience a recovery. This view is supported by favourable base effects, further rate cuts by central banks and an upturn in economic growth.

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More broadly, the bank said the prospect of interest rate cuts at a time of economic and earnings improvement meant its overall preference is for smaller cap stocks.

Despite a recent recovery, it notes the FTSE 250 still trades at a valuation discount of 10% versus its long-term average of 13.4 times earnings.

The bank said: “Higher rates and higher refinancing costs have been weighing on Small Caps.

“With falling inflation, rate cuts from the Bank of England become increasingly likely. This could alleviate fears about refinancing problems in UK Small Caps.”