'Never been stronger': Investors pile in UK stocks as next U.S.-alternative

The UK's FTSE 100 surged 6.7% in Q3, reaching a record high, driven by perceived undervaluation and its revenue insulation from a strong euro, unlike the DAX which saw a 0.1% decline as German fiscal stimulus enthusiasm faded. Analysts note UK stocks trade at a 7% discount, offering compelling value and robust EPS growth prospects, while a strong euro presents a headwind for export-heavy continental European firms. This shift highlights a tactical rotation within European equities, though some strategists maintain a long-term cautious "rent, don't own" stance on the broader region.

Analysis

A significant rotational shift is underway within European equity markets, with investor sentiment pivoting from Germany to the United Kingdom. The UK's FTSE 100 experienced a 'spectacular' third quarter, gaining 6.7% to reach a record high, marking its best quarterly performance since the end of 2022. This contrasts sharply with Germany's DAX, which shed 0.1% over the same period as enthusiasm for its 'fiscal bazooka' has evaporated due to slow deployment, a sentiment confirmed by Deutsche Bank. The case for the UK is underpinned by a compelling valuation argument; Morningstar analysts note the UK market trades at a 7% discount to fair value, more than double the 3% discount seen in the broader European market. Furthermore, the FTSE 100's composition, with approximately 80% of revenues generated abroad, provides a natural hedge against domestic weakness and benefits from a weaker sterling. Conversely, continental firms face headwinds from a strong euro, which has appreciated 13.5% against the dollar year-to-date, pressuring the earnings of large exporters. This divergence is reflected in earnings expectations, with a solid 10% EPS growth forecast for UK large caps into 2026, contrasting with less certainty for Europe. The strength in the UK is exemplified by strong Q3 gains in commodity stocks like Fresnillo (+63.9%) and a 22% year-to-date surge in turnaround plays like Diageo (DEO). Despite this tactical opportunity, some strategists maintain a cautious long-term view, advising to 'rent, not own' European equities due to structural headwinds relative to more dynamic US and emerging markets.

Key Decisions for Investors

• Consider overweighting UK equities relative to continental European indices, leveraging the UK's attractive valuation discount and the insulation its internationally-focused firms have from currency headwinds.
• Monitor the strength of the euro, as its continued appreciation could further erode the earnings of export-heavy continental European companies, reinforcing the relative appeal of the UK market.
• Investors should assess specific UK value opportunities, such as commodity-related stocks that have shown strong momentum and turnaround stories like Diageo (DEO), which is highlighted for its compelling valuation and new strategic plan.
• Maintain a tactical view on European exposure, recognizing that while current conditions favor the UK, the long-term structural case for the region remains challenged, warranting a readiness to pivot if macroeconomic tailwinds fade.