With US equity valuations on the rise and sentiment turning against emerging markets, many value investors are turning their attention to Europe. While the UK equity markets are approaching their historic ceiling, the point just before a market top in 2000 and 2007, valuations are actually quite low and exposure to growing business investment could be a good way to beat other developed market returns.

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UK CAPE at a 17% discount to history

“Although the UK market is close to all-time highs, valuations are not. Over the past 40 years, when UK equities have been similarly priced they have never fallen on a two-year view,” writes Barclay’s analyst Ian Scott in an April 11 report. “We think there is healthy upside to 7400 for the FTSE 100 by year-end, implying an 11% gain.”

CAPE is currently at 12.2 for the UK market, 17% below the long-term average, and price-to-book is in line with the 40 year average. Over the last few decades the UK stock market has never had negative two-year returns when valuations were so low. While the absolute level of the FTSE 100 seems like cause for worry, valuations make the UK look pretty attractive. This is especially true when the UK will be one of the beneficiaries of capital flows from EM to DM as the global money supply tightens, and it doesn’t have the same potential problems that the rest of Europe is facing.

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Focus on value, B2B: Scott

Not only are overall valuations low, but UK value stocks are trading at a heavy discount to growth, approaching a long-term floor that has only been reached a couple of times in the last forty years. Scott thinks investors should be overweight on value, but he also likes business-to-business exposure more than business-to-consumer. While consumer confidence is on the mend, consumption hasn’t rebounded as fast as corporate investment, so at least over the next year B2B looks like it could have outsized returns.

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“Heightened corporate activity is one potential catalyst. With credit markets now fully normalised, M&A activity is likely to be a bigger feature in the next two years,” writes Scott.

M&A has been at a low level for the last couple of years, but this is actually good news for anyone thinking about investing in UK value stocks both because the eventual rise in M&A should drive returns and because the lack of such activity is another argument that UK equities are nowhere near a market top.