Cheap shares make UK a profitable market in an age of détente

Investors can take advantage of bargain share prices in UK markets as important events in the coming weeks could trigger a re-rating. We’ve already seen strong gains in shares we highlighted a month ago and it looks as though there is still plenty of room for them to run.

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Back from the brink

Stock markets around the world have breathed a sigh of relief as tensions have cooled significantly in the past week. Trump has walked back his rhetoric, and more importantly his tariffs, aimed at crippling the Chinese economy, and China has done likewise with both sides agreeing to a 90 day pause and tariff reduction. India and Pakistan have agreed to a US-brokered ceasefire after a worrying escalation between the two nuclear powers in the disputed Kashmir region.

In Gaza there is hope that Trump’s major diplomatic mission to the Gulf states this week, combined with the release of hostages, will offer some progress on a lasting ceasefire deal. Finally, there is Ukraine where after three years of bitter fighting the two sides get round a table in Turkey this week and, hopefully, start hammering out a peace deal. Whisper it quietly but there are encouraging signs we are entering a period of détente.

UK comes in from the cold

This is nowhere more important than the UK that has been somewhat left out in the cold on the international trade scene since we voted to leave the European Union (EU). The EU remains critically important to the UK as a trading partner, contributing 51% of all imports and 41% of all exports last year. Exports to the EU in 2024 were 18% below the pre-Brexit period according to a House of Commons report. What exports we do have are now slower and cost more thanks to mountains of paperwork that needs completing for overseas trade.

While the UK is not quite the nation of shopkeepers it once was, it still desperately needs a rapprochement with its continental trading partners. The period of Brexit naval gazing has been damaging to the UK economy as we lost our way. But our confidence and reputation as a trusted broker and middleman in international trade is showing signs of returning, and that’s important as the economy relies on the export of goods and services, brokering trade and the efficient flow of capital around the world.

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More recently the trade deal with India, while not huge in size, as exports only make up 2% of the UK total, was a clear sign that we had regained our footing and can get deals done on the international stage. This was reinforced by the UK being the first country to agree a tariff reduction deal with the US. All eyes now turn to London on 19 May for the all-important summit between the UK and the EU.

Resetting the Continental relationship

Keir Starmer has stated he wants to reset the UK’s relationship with the EU and reduce barriers to trade. Now that the UK has a framework in place with the US, there is room to find agreement with the EU on food and agricultural standards and recognition of professional qualifications. Even the most grizzled of Cornish trawlermen would have to admit that an agreement with the EU would be beneficial to the UK’s fishermen and farmers.

The size of the prize is immense, using a very rough measure of just balancing the UKs near £100 billion trade deficit with the EU could be worth about 1.5% of GDP growth. The Bank of England governor Andrew Bailey said the UK must “do everything we can” to rebuild trade with the EU.

The signs are encouraging, Emmanuel Macron is due to make a state visit in July for the first time in his eight years in office and the first by a French President since 2008. Gone are the solo chest thumping visits to Ukraine of the Boris Johnson and Rishi Sunak years, and in is the UK showing a united front with Keir Starmer, Macron and German chancellor Friedrich Merz looking positively pally on the train to a recent Ukraine security meeting.

Brexit brake on UK markets

Given the uncertainty of quite where the UK sat in the world economy, perhaps the lacklustre performance of our equity markets can be explained by the Leave vote in June 2016. The blue-chip FTSE 100 has only managed share price gains of 35% and the wider FTSE 250 just 20% since the Brexit referendum almost a decade ago, and that is thin gruel when compared to returns of 75% on the French CAC 40 and 129% for the German Dax during the same period. Include dividends and it’s better – FTSE 100 has returned 91% and the FTSE 250 a touch above 53% - but that’s still much worse than rivals.

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The US is light years ahead with share price gains of 377% from the NASDAQ 100 and 179% on the S&P 500, or 225% on a total returns basis, respectively over the past nine years. A large part of that is also down to tech stock outperformance of which European and UK markets have less exposure. Nevertheless, the question of how the UK will resolve its relationship with the most important trading partner has been a serious overhang on our equity markets. The volatility introduced from the chaotic 2022 Liz Truss budget that sent the pound plunging and the cost of borrowing soaring only compounded matters.

UK markets gain momentum

These more recent optimistic signs in the UK’s investment prospects have not been overlooked by investors. Since the start of the year the UK markets have outperformed their US peers, with the FTSE 100 up 4.1%, while the S&P 500 and Nasdaq are pretty much flat. The backdrop for the UK economy is also encouraging as pressure on household finances are easing.

Inflation is more manageable, with the Consumer Prices Index (CPI) up by 2.6% in the 12 months to March 2025, down from 2.8% in the 12 months to February and well below the peak of 11% we saw at the end of 2022. Interest rates are coming down, with a 0.25% cut to 4.25% in May and analysts expecting a further 0.5% reduction to 3.75% by the end of the year, which will help mortgage costs. The oil price dropping to around $65 per barrel is slowly feeding through to lower pump prices, all of which creates some more breathing space around disposable income, which the Office for Budget Responsibility (OBR) expects to return to pre-Covid levels by the end of the year.

Something interesting is beginning to happen under the bonnet in UK markets that investors can benefit from. There is plenty of potential from a re-rating with the FTSE 250’s price/earnings (PE) ratio of 10.2 at a discount to the blue-chip FTSE 100 on 12.4, the S&P 500’s PE of 28 and Nasdaq 100 on 39. Following the recent announcements of the US and China pausing tariffs and the UK trade deals it hasn’t been the blue-chip companies streaming ahead but the smaller doers and makers on the UK markets in the manufacturing, industrial, automotive, chemicals and household goods sectors driving these returns. During the five days to Wednesday 14 May, while the FTSE 100 has been largely flat, the FTSE 250 is up just over 2%.

Industrial engine starts firing

Looking in more detail at what has driven that over the five days, and again it’s those smaller industrial and manufacturing focused names leading the pack.

Electronics distributor RS Group (LSE:RS1) is up 16% to 596p, Coats Group (LSE:COA) the industrial thread manufacturer up 10% to 78p, and Dowlais Group (LSE:DWL), the automotive engineering group, which was formerly GKN automotive but demerged two years ago, up 10% to 67p, during the past five days. The engineering group Senior (LSE:SNR) that works in aerospace and energy sectors is also up 8% to 160p during the same period.

Profiting from the playbook

We highlighted exactly this feature in our playbook for the recovery analysis a month ago when we focused on the prospects for the UK building sector. The S&P Global UK Construction PMI suggest the sector is stabilising as it edged up to 46.6 in April, from 46.4 in March, where anything below 50 signifies contraction. But there are signs of green shoots, as the residential sub-index recorded its best figures for the year.

Tim Moore, Economics Director at S&P Global Market Intelligence, said: “Output growth projections improved to the highest level so far this year, with a number of survey respondents citing the prospect of a turnaround in workloads across the residential building segment."

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This encouragement was echoed in Wickes Group (LSE:WIX)’s first-quarter trading update, with sales up 6.9% year-on-year, or 5.5% on a like-for-like basis, driven by a strong performance from the retail DIY sector, the shares jumped 9% on the day to 214p, and are now up 23% from when I mentioned them in this column on 9 April, and higher still since ii’s Edmond Jackson tipped them at the start of last month. It’s a similar story for Kingfisher (LSE:KGF) shares up 27% and Howden Joinery Group (LSE:HWDN) up 22%, and Topps Tiles (LSE:TPT) up a more muted 9%.

The other area we said looked attractive after the sell-off was housebuilders, and they’ve certainly made impressive gains with Persimmon (LSE:PSN) up 26% during the past month, Taylor Wimpey (LSE:TW.) up 17%, Galliford Try Holdings (LSE:GFRD) up 18%, Bellway (LSE:BWY) up 26%, Barratt Redrow (LSE:BTRW) up 17% and Berkeley Group Holdings (The) (LSE:BKG) up 17% and well ahead of the index. Having sold off during the past four years, there is still plenty of room for this re-rating to run.

The returns from the construction materials suppliers we looked at have been a bit slower but are still beating the index, with Marshalls (LSE:MSLH) up 20%, brick makers Forterra (LSE:FORT) and Ibstock (LSE:IBST) both up 17% and smaller player Michelmersh Brick Holdings (LSE:MBH) up 12% and Breedon Group (LSE:BREE) up 5%.

There are several other ways into this trade in terms of UK focused exchange-traded funds (ETFs), perhaps through Vanguard FTSE 250 UCITS ETF (LSE:VMID), iShares FTSE 250 ETF GBP Dist (LSE:MIDD), iShares MSCI UK Small Cap ETF GBP Acc GBP (LSE:CUKS).

In interactive investor’s Super 60 list, WS Amati UK Listed Smaller Coms B Acc (B2NG4R3) is highlighted. Investment trust duo Fidelity Special Values Ord (LSE:FSV) (FSV) and Diverse Income Trust Ord (LSE:DIVI), which invest across the UK market, have a bias to UK mid-caps and small-caps. At FSV, the allocation to small and mid-cap stocks currently is just over two thirds of the portfolio.

Other options often flagged by external experts include BlackRock UK Smaller Companies D Acc (B4LHDZ3), JPMorgan UK Small Cap Growth & Income (LSE:JUGI) and Aberforth UK Small Companies Acc (0007272), with the latter investing in ‘deep value stocks’.

John Ficenec is a freelance contributor and not a direct employee of interactive investor.

John owns shares in Michelmersh Brick