Is the UK stock market mispriced? A look at valuation compared to its peers, along with some data about the macro.

At a brief glance, the UK equity markets seems significantly mispriced. I'm not from UK/Europe, so if you are, your comments are especially welcome. Additionally, if you're in the camp of "Only buy US stocks" don't feel like you need to read the following heresy. At the bottom of this comment I give definitions of the various UK / European indices of relevance.

First, as I have written here, the macro situation in the UK has been a major disappointment compared to its G7 colleagues. I put together this album in January (12 graphs) making this case. Thus, it isn't unexpected that its stock market naturally trails the US/Europe. Up to a point.

The FT had a recent article about the UK's stock market. Some of the graphs and statistics are striking.

• Graph 1: A decade of sadness for the FTSE 100 versus the S&P 500.
• Graph 2: If not bad enough, here are UK indices versus the rest of the world.

The resulting valuation gap is remarkable:

On one crude indicator, price/earnings, FTSE 350 stocks were virtually equally valued to global shares on the eve of the referendum, with both at 18.6 according to Bloomberg data. Now they’re about half the price: as of last Thursday, the FTSE 350 had a price/earnings ratio of 10, while MSCI’s World Index stood at 19.8.

• Graph 3: PE Ratios for the FTSE 350 vs. Europe (w/ UK included) and the S&P 500..

How extreme are these P/E ratios? According to Yardeni Research, here are some forward P/Es for other countries/region as of last week:

• Japan: 14.3
• US: 19.1
• European Monetary Union (EMU): 11.9 (so countries in the euro-zone, no UK)
• Emerging Markets: 11.9
• World: 16.0
• ACW ex-US 12.6
• Germany: 10.6
• France: 12.9
• Spain: 9.9

And the UK: 10.2.

Maybe Germany/France are also too cheap here. But I'll focus on the UK. Right now emerging markets are more expensive on a forward P/E ratio than the UK. It doesn't add up. Perhaps you think the UK's governance is a disaster. Then sure, avoid domestic UK companies (FTSE 250/FTSE 350). But the FTSE 100 is largely multinationals who derive most of their revenue abroad. Should it really be getting a 10 P/E ratio? In theory, the UK has a ton of advantages: strong property rights, world class universities, and life science research, and some of the oldest financial institutions. Brexit was a self-inflicted wound but there are emerging market countries with much worse governance equipped with richer valuations.

Some definitions:

• FTSE 100 is like the S&P 500 for the UK. Its constituents are predominately large multinational corporations that derives 70% of their revenue outside of the UK. It's filled with companies in dull, legacy industries like banking, mining, oil & gas, tobacco, pharma, and consumer staples.
• The FTSE 250 is the next biggest 250 companies, typically mid-caps. These companies are more inward-looking and a better reflection of the domestic UK economy.
• The FTSE 350 is the combination of FTSE 100 + FTSE 250. Small caps are not included in any of these.
• The "FTSE AIM All Share Index" is the analogue of the Russell 2000 for the UK.
• The Stoxx Europe 600 is like the S&P 500 for Europe, and includes the UK.