Global investors have grown so optimistic about the world economic outlook and the tech stock boom that they have increasingly shunned the UK stock market this year, perceived as overly defensive and safe-haven in nature. This has left share buybacks and mergers & acquisitions as among the few positive drivers for the London market.

Meanwhile, the UK market, labeled a "contrarian trade," has significantly underperformed the global tech bull run. However, some fund managers see potential for it to stage a comeback during the next market selloff.

The UK stock market has lagged severely behind its European and US counterparts this year, failing to participate in the investor frenzy for cyclical stocks and AI-related tech plays. At the same time, stocks focused on the domestic UK economy have been broadly weighed down by insufficient reform measures, sluggish economic growth, and high interest rates. The political turmoil surrounding the impending departure of Prime Minister Keir Starmer has further deterred international buyers.

The latest Bank of America Global Fund Manager Survey reveals that global investors have reduced their allocation to UK equities to a net underweight of 37%. This is the lowest allocation level since August 2020, when market sentiment was still reeling from the severe impact of the COVID-19 pandemic. As the equity bull market prospects for other developed markets and emerging markets like South Korea and China grow increasingly optimistic, the UK is now listed among the "significant contrarian trades" mentioned in the survey, seen as a potential tool to hedge against the risk of the "AI investment boom peaking."

The survey highlights that being long UK stocks has become a classic contrarian trade. Global capital is heavily concentrated in chasing assets sensitive to artificial intelligence, technology, and economic growth. The UK market, with a tech sector weighting of only about 1.2%, defensive sectors like consumer staples and healthcare comprising about 34%, and oil & gas stocks around 10%, has consequently continued to underperform during this phase of global economic optimism and cyclical stock leadership.

Simultaneously, extreme underweight positioning, cheap valuations, corporate buybacks, and cross-border M&A collectively give UK stocks a contrarian value proposition where "bad news is largely priced in, and any positive catalyst could trigger a re-rating." This is why some fund managers believe one must short the UK when global markets rally and immediately buy the UK when tech stocks fall, as a form of contrarian hedging.

During periods of accelerating global growth, stable interest rates, and continued upward revisions to tech earnings, the UK market may continue to lag behind high-beta tech markets. However, when the economic boom peaks, tech valuations contract, geopolitical risks push oil prices higher, or investors regain a preference for dividends, cash flow, and defensive assets, UK large-cap stocks could achieve relative outperformance, supported by energy, healthcare, consumer staples, and low valuations.

Therefore, being long the UK is more akin to an insurance position hedging against an "overcrowded global tech and cyclical trade" rather than an unconditionally effective contrarian formula.

When the World Chases Tech, UK Defensive Assets Become an Unloved Market

The core issue for the London equity market is its inability to provide what the market currently craves most: winners in AI computing infrastructure and cyclical stocks highly sensitive to economic growth. The tech sector has the lowest weighting in the FTSE 350 index at just 1.2%, while defensive sectors like consumer staples and healthcare command a high weighting of 34%. The oil and gas sector, at 10%, makes the benchmark more susceptible to crude oil price fluctuations compared to peers.

UK market performance lagged as concerns over a war involving Iran subsided following a temporary truce in April, but its problems are not merely short-term drivers; they also involve structural challenges. As shown in the chart, preferences for cyclical and tech stocks have caused trouble for the UK's benchmark FTSE 100 index. When cyclicals and tech outperform defensives, UK large caps underperform their global peers.

"UK equities continue to experience net outflows from domestic mutual funds," said Sharon Bell, a senior European market strategist at Goldman Sachs, and her team. She noted that outflows from domestic mutual funds in the first quarter approached £20 billion ($26.8 billion). "Annualized, this would be significantly higher than levels seen in recent years."

Bell and her team indicated that retail investors are showing a similar pattern, adding that inflows from this group are unlikely to increase unless economic expectations improve. Pension funds and insurers remain net sellers, disposing of assets at a pace roughly in line with recent years, while foreign investors have been modest buyers. This leaves corporate actions like share buybacks and M&A to support the market.

Goldman Sachs data shows that strategic M&A volume in the UK is higher than in the rest of Europe. The UK is indeed fertile ground for M&A deals, particularly attractive to private equity bidders and buyers seeking industrial assets. The bidding war for easyJet, Xavier Niel's offer for Vodafone Group shares held by Emirates Telecommunications Group, and Prologis's takeover bid for property firm Segro are recent examples of UK stocks' attractive valuations for foreign buyers.

"I think that speaks to the very significant valuation discount," said Laura Foll, a UK equities portfolio manager at Janus Henderson Investors. She pointed out that valuations in every UK sector are below those of their US counterparts. She stated that increased M&A activity is an important catalyst for the UK equity market, noting there is currently "a lot of takeover activity."

After a severe de-rating over the past decade, UK stocks are now among the cheapest in developed markets. The FTSE 350 trades at a valuation discount of nearly 35% relative to the MSCI World Index. While the UK's lack of high-valuation growth stocks and its overall tilt towards a value-oriented market explain part of this discount, this valuation gap remains substantial even when comparing the same sectors across markets.

The UK Market's True Value: A Low-Valuation Safe Haven During a Global Risk Sentiment Reversal

The UK stock market, with its low tech weighting and defensive sector structure, has persistently underperformed while global capital chases AI and cyclical growth. However, extreme underweight positioning, deep valuation discounts, and defensive attributes from sectors like energy, healthcare, and consumer staples could allow it to achieve relative outperformance when the economic boom peaks, tech stock valuations contract, or geopolitical risks escalate.

With current global investor sentiment reaching extremely optimistic levels, some fund managers view the UK equity market as more aptly described as a "contrarian insurance position" hedging against overcrowded tech trade themes.

Beyond the unexpectedly strong M&A volume this year, portfolio manager Foll also emphasized the supportive role of share buybacks for the market. "UK company boards are increasingly buying back their own shares because they realize there is persistent market outflow, so they are creating their own demand," she said. "So, we are seeing more and more UK companies announcing buybacks, including from quite small listed companies."

As shown in the chart, UK stock valuations are significantly cheaper – the FTSE 350 trades at a nearly 35% discount to global equity peers. A renewed escalation of tensions in the Middle East could also provide a respite for UK stocks. A sharp rise in oil prices again might prompt investors and global central banks, including the Federal Reserve, to reassess the impact of energy costs on inflation and interest rates. Typically, UK stocks perform better during periods of global economic uncertainty.

Even so, veteran Wall Street strategists are increasingly hesitant to recommend UK stocks. Barclays' strategy team prefers eurozone equities, while their counterparts at JPMorgan maintain a neutral stance on the UK, citing a lack of catalysts. Beata Manthey of Citigroup downgraded UK equities by two notches to "underweight" this week.

Historical data also shows that UK large-cap stocks, particularly the FTSE 100, seem to be one of the important safe havens during market turbulence, rarely outperforming global equity markets during periods of favorable economic conditions.

"While valuations remain attractive, the UK's defensive, commodity-heavy sector composition is less appealing in an environment of broadening earnings growth and market leadership," the Citigroup senior strategist said. "We continue to prefer cyclical opportunities in other markets and the AI infrastructure-related tech investment boom."