U.K. Markets Are On Sale. Nobody Wants to Buy.

UK stocks and bonds are trading at their lowest levels in decades. That wasn’t enough to draw investors back into the market.

Since Liz Truss won the prime ministerial race in early September, the UK’s FTSE 250, a broad index of domestically focused stocks, has fallen nearly 10%, beating losses in the Dow Jones Industrial Average and the S&P 500. UK government bonds have soared this month to its highest level since 2008. Meanwhile, sterling is trading at its lowest level against the dollar since 1985.

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Investors withdrew a total of $3.7 billion from UK mutual funds and exchange-traded funds in September – an all-time monthly record, according to fund flow tracker EPFR. And withdrawals in October haven’t slowed so far.

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Meanwhile, a September survey by BofA Global Research showed that fund managers have been the most underweight UK equities in almost two years. Sentiment isn’t looking much better for the British pound either, which has continued to see bearish bets against it.

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“It’s an untouchable market right now,” said Viraj Patel, a London-based global macro strategist at Vanda Research. “You could easily bring up a case where things just keep getting worse from here.”

Prime Minister Liz Truss gave a news conference on Friday after ousting her finance chief.


WPA Pool/Getty Images

Investors had already been withdrawing from UK assets for the past few months as they weighed the risks building up in the economy. These include decades of inflation, growing risks of recession and a looming energy crisis.

The unveiling of the biggest tax cuts in the UK since the 1970s sent investor jitters into overdrive. Ms. Truss decided on Friday to reverse key parts of the tax proposal and fire Chief Financial Officer Kwasi Kwarteng.

On Monday, his successor, Jeremy Hunt, said he would reverse almost all of the government’s proposed tax cuts and lower an energy price cap. Before issuing a declaration of urgency to Parliament on the economy, he said: “The most important goal for our country at the moment is stability.”

Investors welcomed the CFO’s announcement that stocks, bonds and the British pound rose on Monday. According to Tradeweb, the yield on the 10-year gilt fell to 3.950% after an intraday high of 4.634% last week. Yields fall when bond prices rise. Meanwhile, the British pound rose 0.8% against the dollar to $1.1305. The benchmark FTSE 100 gained 0.8%.

Still, investors and strategists say they’re bracing for more uncertainty. The Bank of England completed its government bond-buying program on Friday, marking the last opportunity for pension funds to sell long-dated bonds to the central bank. Some market watchers said they were concerned that volatility could rise again.

On paper, UK equities, bonds and the currency are looking cheap on a historical basis. The FTSE 100 on Thursday traded at 8.8 times its forecast earnings for the next 12 months, according to data from JPMorgan Chase & Co., which is lower than 15.7 for the S&P 500 and the 11.2 multiple for an MSCI Europe index ex UK

According to FactSet, the difference between UK government bond yields and US or German debt is the widest it has been in at least a decade.

Low valuations notwithstanding, the turmoil in the new UK government has only reinforced the decision to stay away, said Florian Ielpo, head of macro at Lombard Odier Investment Managers, which has around 67 billion Swiss francs (about 67 billion US dollars) under management.

His concerns include: The conflict the Bank of England has faced in trying to simultaneously loosen and tighten monetary policy. Throughout the year, the bank raised interest rates to fight inflation and planned to start selling its holdings of gilts, as government bonds are called, to tighten the money supply.

But the market turmoil forced the central bank to put those bond sales plans on hold. Instead, the BOE was forced to step in and start buying bonds to stabilize markets.

“These elements are completely incompatible,” Ms Ielpo said, noting that while UK stocks are trading at a deep discount, he sees few opportunities. “We don’t think valuations are a relevant indicator” for UK equities.

Another factor keeping investors away has been the wide swings in the markets. According to FactSet, over the past 16 trading days, the pound has moved more than 1% up or down about half of the days. On Friday, yields on the 30-year gilt, a favorite of pension funds at the heart of the recent turmoil in bond markets, fluctuated 0.66 percentage points in a single day, a move that outside of the past few weeks typically takes months to complete they are played.

Certainly, strong pessimism can also have its own appeal for investors. JPMorgan’s prime brokerage arm has recently seen buyers snap up larger UK-based companies that derive much of their revenue internationally, according to Eloise Goulder, head of the bank’s global market, data and positioning intelligence team. However, she said inflows into domestically focused UK companies remain sparse.

Market sentiment in the UK is very low, she said. “Far lower than the other major regions we’re tracking.”

The turmoil in the UK bond market created a feedback loop that left investors such as pension funds tight on cash and spilled over into other markets. WSJ’s Chelsey Dulaney explains the nature of investing at the heart of the crisis. Figure: Ryan Trefes

Write to Caitlin McCabe at [email protected]

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