When everyone rushes into the AI theme, smart funds seek "reverse trading" to hedge against the selling storm: the UK stock market with both undervalued and defensive attributes.

Global investors have become so optimistic about the global economic outlook and the prosperity of technology stocks that they are increasingly avoiding the UK stock market, which is considered defensive and too risk-averse. This has also made stock buybacks and mergers and acquisitions one of the few positive factors for the London stock market. At the same time, the UK stock market, labeled as "contrarian trading," has significantly underperformed the global technology bull market. However, some fund managers believe it may stage a comeback in the next market sell-off storm. It is understood that the UK stock market has severely lagged behind similar markets in Europe and the US so far this year, failing to participate in investors' fervent pursuit of cyclical stocks and AI-related technology stocks. Meanwhile, stocks focusing on the UK domestic market have generally been hindered by inadequate reform measures, weak economic growth, and high interest rates. The political turmoil surrounding the imminent departure of Prime Minister Keir Starmer has also deterred international buyers. The latest global fund manager survey by Bank of America revealed that global investors have reduced their allocation to UK stocks to a net underweight of 37%. This is the lowest allocation level since August 2020, when market sentiment was still severely impacted by the COVID-19 pandemic. With prospects for stock markets in other developed countries as well as emerging markets like South Korea and China becoming increasingly optimistic, the UK is now being included in what Bank of America fund managers refer to as "significant contrarian trades," seen as a potential tool to hedge against the risk of the "peak AI investment boom." The Bank of America fund manager survey revealed that going long on UK stocks has become a classic contrarian trade. Global funds are concentrating on artificial intelligence, technology, and economically sensitive assets, while the UK market has a technology weight of only around 1.2%, with defensive sectors like necessities and healthcare accounting for about 34%, and oil and gas stocks around 10%, causing it to continuously lag behind during the phase of global economic optimism and cyclical stock leadership. Meanwhile, extreme low position levels, cheap valuations, stock buybacks, and cross-border acquisitions have together made UK stocks possess a "negative value has been fully priced in, a slight catalyst could bring about a revaluation" contrarian value. This is why some fund managers believe that when global stock markets rise, they must short the UK, and buy UK stocks immediately when tech stocks fall, thus engaging in a contrarian hedge trade. During a period of global growth acceleration, stable interest rates, and continued profitability of technology, the UK market may continue to lag behind high beta tech markets; but when economic prosperity peaks, tech valuations contract, geopolitical risks push up oil prices, or investors re-prefer dividends, cash flow, and defensive assets, UK large-cap stocks may achieve relative excess returns through energy, healthcare, necessities, and undervaluation. Therefore, going long on the UK seems more like an insurance position to hedge against the overcrowding of global tech and cyclical trades, rather than an unconditional effective reverse trading formula. While everyone is chasing tech prosperity, UK defensive assets are becoming a niche market The key issue for the London stock market is that it cannot offer the most desired assets of the current market: winners in artificial intelligence computing infrastructure, and cyclical stocks highly sensitive to economic growth. Tech stocks have the lowest weight in the FTSE 350 index, at only 1.2%, while defensive sectors like necessities and healthcare account for as much as 34%. The oil and gas stocks make up 10%, making this benchmark index more vulnerable to fluctuations in oil prices compared to similar indexes. Despite the UK stock market's underperformance as concerns eased after the temporary ceasefire between the US and Iran in April, the problems it faces are not just driven by short-term factors, but also involve structural challenges. As shown in the chart above, the preference for cyclical and tech stocks has been troublesome for the FTSE 100 index of UK benchmark stocks, with the UK large-cap stocks lagging behind global peer markets when cyclical and tech stocks outperform defensive stocks. "UK stocks continue to face net outflows from domestic mutual funds," said Sharon Bell, senior European market strategist for Goldman Sachs and her team. She pointed out that net outflows from domestic mutual funds in the first quarter were nearly 20 billion ($26.8 billion). "If this scale is annualized, it will be much higher than levels seen in recent years." Bell and her team noted that retail investors are exhibiting a similar pattern, adding that the inflows from this group are unlikely to increase unless there is an improvement in economic expectations. Pension funds and insurance companies remain net sellers, with their selling pace roughly similar to that seen in recent years, while foreign investors have been moderate buyers. This forces companies to support the market through stock buybacks and mergers and acquisitions. Goldman Sachs data shows that the magnitude of strategic mergers and acquisitions in the UK is higher than in other European regions. The UK is indeed fertile ground for mergers and acquisitions, especially appealing to private equity buyers and buyers seeking industrial assets. Examples of this include the bidding war for easyJet, Xavier Niel's offer for Vodafone's stake in the UAE Telecom Group, and Prologis' takeover bid for real estate company Segro are the latest examples of UK stocks offering attractive valuations to foreign buyers. "I believe this reflects a very significant valuation discount effect," said Laura Forrester, portfolio manager for UK stocks at Jun LI Henderson Investments. She noted that valuations in every industry in the UK are lower than those in the US. She explained that increased merger activity is an important catalyst for the UK stock market and pointed out that there are currently "a lot of acquisition transactions." After experiencing severe valuation declines over the past decade, UK stocks are now among the cheapest markets in developed markets. The valuation discount of the FTSE 350 index relative to the MSCI World index is close to 35%. Despite the UK lacking high-growth stocks with high valuations, and overall being more value-oriented, which partially explains the discount, the valuation gap is still significant even when comparing the same industries. The true value of the UK stock market may lie in providing a undervalued safe haven during a global risk aversion reversal The UK stock market has continuously lagged behind as global funds chase artificial intelligence and cyclical growth, due to its low tech weighting and defensive industry structure; however, extreme underweight levels, deep valuation discounts, and defensive attributes such as energy, healthcare, and necessities mean it may achieve relative excess returns during economic prosperity peaks, tech stock valuation contractions, or geopolitical risks worsening. With global investor sentiment now reaching extremely optimistic levels, some fund managers believe the UK stock market is better described as a contrarian hedge against the overcrowding of tech trading themes. In addition to unexpectedly strong M&A activity this year, portfolio manager Forrester also emphasized the supportive role of stock buybacks in the market. "UK corporate boards are increasingly buying back their own shares because they realize that market funds are continuously flowing out, so they are creating demand themselves," she said. "So, we are seeing more and more UK companies announcing stock buybacks, including companies of relatively small size." As shown in the chart above, UK stocks are much cheaper in comparison - the FTSE 350 index has a valuation discount of nearly 35% compared to global peer markets. The escalation of tensions in the Middle East may also provide a breathing space for UK stocks. With oil prices surging again, investors and global major central banks, including the Federal Reserve, may reassess the impact of energy costs on inflation and interest rates. Typically, UK stocks perform well during periods of global economic uncertainty. Nevertheless, Wall Street senior strategists are increasingly reluctant to recommend UK stocks. The Barclays strategy team favors eurozone stocks, while counterparts at JPMorgan maintain a neutral stance on the UK, citing a lack of catalysts. Citi group's Beata Manch is downgraded UK stocks by two levels to "underweight" this week. Historical data also shows that UK large-cap stocks seem to be an important safe haven during periods of market turmoil, especially the FTSE 100 index rarely outperforms global stock markets when the economic environment improves. "Although valuations are still attractive, in an environment where profit growth keeps expanding, the UK market's defensive and commodity-heavy industry structure is less appealing," said the Citi senior strategist. "We still prefer cyclical investment opportunities in other markets and technology investment booms related to AI infrastructure." The above content translates the English text into the Chinese language.