UBS Affirms Neutral Stance on UK Stocks, Emphasizes Earnings Growth Over Valuation Leverage

The Swiss financial institution UBS has reaffirmed a neutral investment stance on the UK equity market, reflecting on the FTSE 100 Index's marked valuation increases during 2025. Despite the index achieving a notable 22% price appreciation last year, UBS cautions that most of these gains stemmed from a limited subset of approximately 25 companies, pointing to a narrowly distributed performance largely influenced by firm-specific developments.

The brokerage's Chief Investment Office observes that the FTSE 100 currently trades at a forward price-to-earnings ratio of 13.3 times, representing a 9% premium over its two-decade average. Given that government bond yields remain elevated, UBS advises that the market possesses only limited scope for additional valuation multiple expansion.

Matthew Gilman, UBS's CIO Equity Strategist, articulated a base case target for the FTSE 100 at 10,500 points by the end of 2026, an upward revision from the 10,150 level anticipated earlier this year on January 21. UBS anticipates earnings growth of 5% in 2026, accelerating to 15% in 2027, premised on improving global economic conditions.

Examining sector contributions to the FTSE 100's robust performance in the past year, UBS highlights several key areas. Banking stocks have risen due to resilient earnings, while pharmaceuticals benefited from clearer U.S. healthcare policy. The defense sector demonstrated strong gains as Europe's focus on defense capabilities intensified. Additionally, mining companies capitalized on substantial price increases in commodities such as gold, silver, and copper.

While these sectors experienced outsized reactions, UBS signals that such dramatic upward moves are unlikely to repeat in 2026. In fact, the brokerage expects equity returns to lag behind earnings growth going forward. UBS points to structural challenges confronting the UK market, including comparatively weaker long-term growth prospects driven by limited exposure to emerging global trends like artificial intelligence and energy-related resources.

The composition of the FTSE 100 also imposes constraints. Its defensive-heavy sector allocation, constituting about one-third of the index's market capitalization, is projected to cause the UK equities to underperform European markets more sensitive to economic cycles.

Within the wider European context, UBS expresses preference for the Eurozone and Germany. It also favors sectors such as banking, industrials, information technology, utilities, and real estate, all poised to benefit from cyclical recoveries, structural economic shifts, and declining interest rates.

Given that approximately 75% to 80% of the FTSE 100 companies’ revenues are generated outside the UK, fluctuations in currency valuations significantly affect returns. UBS notes that sterling's recent appreciation has exerted downward pressure on local currency returns.

UBS envisions an upside scenario for the FTSE 100 reaching 11,300 by December 2026. This scenario assumes accelerated global growth, rising commodity prices, a weaker sterling, increased U.S. investor interest in UK equities, or accommodative policy actions such as faster rate cuts or substantial fiscal interventions.

Conversely, a downside case projects a drop to 7,200 points. This bearish outlook hinges on the potential emergence of a global recession, renewed U.S.-Europe trade tensions, sustained inflation levels that keep central bank interest rates high, declines in commodity prices that would adversely impact earnings (given that commodities contribute about a quarter of FTSE 100 profits), or further appreciation of sterling.

Despite a roughly 15% decline in UK equities over the past three years, UBS expresses optimism for profit improvements supported by reasonable current valuations and conducive global policy environments.