Why the UK stock market has been less volatile than America

The much-maligned UK stock market is having a less turbulent summer than America, and ultimately that comes down to two factors: valuation and relative levels of expectation.

Investors may view the fact that the headline FTSE 100 index has dropped less than the US S&P 500 as cold comfort, but one possible explanation for the FTSE 100’s greater resilience is the US market has done so much better – so its valuation is higher and expectations are higher.

Over the past five years, the S&P 500 has risen by 82%, while the FTSE 100 has only risen by 12% over the same time period. As a result, this may leave US markets more exposed on the downside in the event of any unexpected shocks.

Source: Sharepad, LSEG Refinitiv data

The UK benchmark trades on a lower valuation multiple – at just 12.5 times forward earnings for 2024 and 11.5 times for 2025, compared to the S&P 500’s 23.3 times and 19.9 times, based on consensus analysts’ forecasts and S&P Global Research.

Meanwhile, analysts are forecasting a second straight drop in aggregate earnings from the FTSE 100 in 2024, of 9%, with a modest 8% rebound in 2025, to leave next year’s predicted net income figure at £183 billion, a fraction below 2023’s £185 billion. Some investors may see that as reasonable given the uncertain global economic outlook. In the US, however, S&P Global research suggests US analysts are forecasting 11% earnings growth in 2024 and 17% in 2025 – and that is on top of 8% growth in 2023.

There are good reasons why the trajectories could be so different – America may still be basking in the fiscal stimulus provided by the Biden administration’s CHIPS and Inflation Reduction Acts, benefitting from increased onshoring and also the S&P 500’s much greater exposure to areas such as technology, where hopes for an AI-inspired spending and productivity boom continue to run high.

But this also increases the risk of downside in US equities should any unexpected disappointment creep up and sandbag those earnings forecasts – either because the economy slows down; AI fails to deliver a satisfactory return on the initial huge outlay made by corporations who then pause spending here, or even retrench; or there is an another unforeseen shock. Just look at the sharp falls in US equities – and the Magnificent Seven group of technology stocks in particular – in 2022 when corporate earnings stumbled, just as interest rates began to rise and supply chains unwound after the damage caused by Covid and lockdowns. This seems to have been forgotten, even though it was barely two years ago.

The UK may be more sheltered from these risks because it has a smaller price tag and lower valuation. Although it would be wrong to say it is entirely immune to such threats, especially as the US is the world’s largest economy and an important trading partner. The FTSE 100’s less volatile performance recently suggests it could offer some protection in the event of a wider market fallout, partly as valuations and hopes are lower and partly because it has a greater exposure to stodgier or less cyclical sectors, such as consumer staples, telecoms, utilities and health care. Some of these areas, notably staples and utilities, are seen as ‘bond proxies’ and could do relatively well if the yield on government bonds declines in anticipation of interest rate cuts, as the yields offered by these stocks could look more attractive.

Sector weighting by market capitalisation (%)

Source: LSEG Refinitiv data, S&P Global Research, Vanguard

This may all be academic if markets regain their footing. A rally is by no means out of the question as investors do seem to have rather lost their marbles – a surge in the VIX, or fear index, to an intra-day high of 65 suggested that markets at one stage feared an outcome as bad as that seen in 2008 during the financial crisis or 2020 during Covid.

In this respect, the VIX could be a handy contra-cyclical indicator, at least in the near term.

Its long-term average reading is 19. A long spell of readings at 12 or below can be suggestive of very bullish sentiment, even complacency, so it may not take much to frighten markets into action. Equally a spate of readings above 30, or spikes higher still, could be suggestive of panic and therefore that markets may be oversold as investors blindly dump stocks and mean markets are potentially undervalued.

Source: LSEG Refinitiv data

In this respect, volatility can be the investors’ friend, as it presents them with a chance to buy assets cheaply (when others panic) or sell expensively (when others get carried away and over-exuberant). The skill is to build a portfolio with sufficient downside protection and robust characteristics that it can see the investor through to the other side of any squalls, without them being a forced seller as they have taken too much risk, or over-reached themselves, at the wrong time of the cycle.

All this does is distil Warren Buffett’s saying that investors, if they are brave enough to try and time the markets, should be fearful when others are greedy and greedy when others are fearful. The more an asset’s price and valuation go up, the less attractive that asset may be, and the more it goes down then the more attractive it may be, over the long term. Ultimately, valuation and the price paid dictate long-term investment returns, not fancy narratives, whether they are AI-related or not.