As we approach the end of the year, it looks like it will be logged as another strong one for investors. 2025 has so far brought positive total returns across a range of assets, with domestic and international equity, as well as gold, being the stand outs. The tariffs chaos of the spring seems a very long time ago indeed.
UK and international equity returns have been just over 20% year to date. The drivers behind this can be broken down into three categories: changes in earnings per share (EPS), dividend returns, and swings in valuation. These three explanatory variables shed some light on the different drivers powering equity returns.
Domestically, the biggest factor has been an appreciation in valuation. Over the largest 100 UK businesses, earnings per share look likely to increase by only around 2% in 2025. We’ve had the dividend too, but by the time the year is out will only have added around 4%. That leaves the majority of the growth attributable to a change in valuation.
Having entered the year trading on a shade over 11, the MSCI UK index PE ratio (price divided by expected earnings per share) is now at 13 times. That may not sound like much of a change, but it is a double-digit percentage increase. Followers of our investment commentary will know that we had our eyes on the possibility for an upwards re-rating for some time. We are thus grateful for the boost this has provided.
Internationally, the drivers have been a little different. While the contribution from dividends is predictably lower (the UK remains one of the higher yielding equity markets) the benefit we have seen from increased earnings looks set to be significantly greater. Global earnings likely to jump about 11% higher this year. Valuation has sneaked up, but has only contributed around 7% to total return, ie about half the boost the UK has enjoyed.
However, we are mindful that this means the goalposts have moved from where they were at the start of 2025. While still trading on a significant discount to the global market, to expect a similar uptick in rating in the UK over 2026 from this higher base requires a large amount of blue-sky thinking. A 10% jump would put the PE ratio beyond a standard deviation ahead of its long-term average. We also note the yield on offer is near historical lows, at around 3.5%.
Does that make us fearful? No – not necessarily. This is because the third component of total return, the contribution from earnings growth, is anticipated to be much stronger than it was in 2025. As it stands, analysts have growth of 10% pencilled in. This actually carries greater significance in that the more optimistic earnings forecasts also help explain the higher valuation. Greater growth commands a higher price tag – ie you get what you pay for. That said, clearly this makes it important the UK’s leading businesses hit their earnings projections.
These dynamics are interesting. 2025 earnings have been weighed down by weakness in the natural resources sector. Falling commodity prices have depressed earnings, and the scale of businesses like Shell, BP and Rio Tinto (all top 10 UK businesses by market cap) means the stabilisation in earnings that is expected in 2026 is significant. Elsewhere, we have seen a succession of strong results across much of the UK market, and that will be underpinning confidence that earnings can continue rising in 2026.
If we put these two themes together, one can certainly make a case for growth in the order of what is pencilled in. It is much the same story in the US, the most important international market. Tech earnings remain strong and justifiably attract the headlines, but one cannot lose sight of how the rest of the market is also delivering strong numbers. 83% of the companies reporting in the autumn reporting season delivered results ahead of expectations, with all 11 sectors of the market delivering revenue growth. This topline growth is expected to continue such that consensus has US earnings rising by another 14% in 2026.
This sets an encouraging backdrop for markets as we head into 2026, but of course we remain mindful that conditions can change.
Politics is one of the key risks. But as we spoke about last week, we do not see the UK budget as one that moves the dial. In short, most of the announcements around key policies were broadly as anticipated, and the UK market is actually rather detached from the UK economy anyway.
Perhaps the main risk is around AI. Curiously, the threats range from us entering ‘emperor’s new clothes’ territory and the hype falling flat, to the technology picking up pace and disrupting established business models faster than is currently expected. Of course, there are relative winners and losers in each scenario. It has so far been too early to tell where we are on this front, but 2026 may well be the year that the fog starts to clear.
George Salmon – Senior Investment Analyst
FPC25594
Hawksmoor Investment Management Limited is authorised and regulated by the Financial Conduct Authority (www.fca.org.uk) with its registered office at 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. This document does not constitute an offer or invitation to any person in respect of the securities or funds described, nor should its content be interpreted as investment or tax advice for which you should consult your independent financial adviser and or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. The editorial content is the personal opinion of George Salmon, Senior Investment Analyst. Other opinions expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represent the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. Currency exchange rates may affect the value of investments.
