You might think this means the UK is cheap relative to the US. It doesn't. The correlation between the UK-US price ratio and subsequent annual changes in the All-Share index since 1969 has been zero. This means the fact that the UK is low relative to the US tells us nothing about the chances of the UK market rising or not. The very fact that the US-UK price ratio has risen for most of the last 20 years tells us that the ratio doesn't mean-revert very much.
Instead, the ratio tells us something else - that the UK is a defensive market, relative to the US. When markets rise, the US tends to outperform the UK. And when they fall, the UK tends to outperform. Since 1990, each percentage point annual change in the S&P 500 has been associated - on average - with a change of 0.75 percentage points in the All-Share index. The UK's rare periods of outperformance in the last 20 years have tended to come in bear markets such as the tech crash of the early 2000's and the financial crisis of 2008-09.
This means we'd expect to see the US market at a high relative to the UK after stock markets generally have risen.
Herein, though, lies an oddity. Around the world, defensive shares do better than they should. But this is not true of defensive markets - at least, not if we compare the UK with the US. Even controlling for moves in the US market, UK shares have fallen by an average of 0.8 per cent per year since 1990. The UK has a negative alpha with respect to the US.
One reason for this could be that UK companies have delivered slightly disappointing performance relative to their US counterparts. Another possibility is that US equities carry more systematic risk than UK ones - on top of ordinary market risk. If this is the case, we'd expect the UK to have a negative alpha for the same reason that insurance policies cost us money on average - it's the price we pay for reducing risk. The fact that the UK's rare period of positive alpha came during the financial crisis is consistent with this possibility.
Whatever the reason for the UK's long-run underperformance, the fact is that a high ratio of US share prices to UK ones is no reason to expect the UK to do well. The best hope for UK equities is that the US continues to rise, and that this will drag up the UK.
