The FTSE 100's record close last week attracted the attention of investors who had written off UK equities after years of underperformance. The question is whether this represents a genuine rerating or a temporary respite.
The Composition Advantage
The FTSE 100 is not the UK economy. It is a collection of large, globally-oriented businesses that happen to be listed in London. Many of them earn the majority of their revenues outside the United Kingdom.
This composition has historically been a weakness — UK investors have been less exposed to high-growth technology than their US counterparts. In the current environment of elevated inflation and commodity prices, the FTSE's heavy weighting towards energy, mining, and financial services has become an advantage.
The Valuation Question
UK equities trade at a discount to their US equivalents that has persisted, and widened, for the past decade. The case for mean reversion is compelling on paper. The catalyst for it has been harder to identify.
Some investors are now pointing to activism, M&A, and buybacks as the mechanism. Several FTSE companies have been targeted by private equity acquirers attracted by what they see as unjustifiably cheap valuations.
Risks to the Rally
The same commodity exposure that has driven recent outperformance is a double-edged sword. A slowdown in Chinese demand, or a resolution of the conflicts currently supporting oil prices, could quickly reverse the sector dynamics that have been so favourable.
