Why valuations matter when nothing else is certain

Mark Costar, senior fund manager of the J O Hambro UK Dynamic Fund, highlights how rising uncertainty is creating fresh market inefficiencies and opportunities for long-term investors.

Global economic developments in 2026 have served as a sharp reminder that there is often more we do not know than we do. Uncertainty is on the rise. But for long-term investors, this is not necessarily a bad thing. Rising uncertainty can lead to more visible market inefficiencies.

With recent news flow dominated by the conflict in the Middle East, it is easy to miss that the global capex cycle – the first in 25 years – continues to accelerate. Hyperscaler capex forecasts were upgraded again in Q1, with Google and Amazon now set to spend close to $200bn each in 2026 alone.

Geopolitics, technology, society, and capital markets are all changing at a rapid pace, while all becoming increasingly interconnected. This is creating ‘deep uncertainty’ – a concept from complexity science describing situations where interacting crises produce outcomes that strain human comprehension. While we have no crystal ball, we are acutely aware that the breadth of possible outcomes is increasing.

However, we believe the UK market represents a diverse set of companies with experienced management teams that have idiosyncratic levers to unlock embedded equity value.

Reality is beginning to look warped

Stepping back to observe how these narratives are taking hold can help highlight where potential market inefficiencies may be emerging. In this context, the continued underperformance of the FTSE 250 is a curious anomaly. Whilst its underperformance versus the FTSE 100 can be rationalised on the grounds of liquidity (albeit not its scale) those same arguments do not hold when we consider it has also underperformed the FTSE Small-cap index.

Although there were clear signs of oversimplification, including companies basketed into ‘AI winners’ or ‘AI losers’, it is appropriate to question enterprise valuations in an increasingly wide range of sectors. AI disruption of the legal services market was only a matter of time.

Yet the valuations of companies like RELX did not provide any headroom for this uncertainty. Terminal values – the proportion of a company’s valuation tied to its long-term forecast – really matter. In times of disruptive innovation, a clear margin of safety is needed to accompany any long-term assumptions to reflect what cannot be known with certainty.

We must be also wary of the rise in tail risks – the “unknown unknowns.” A structural advantage of operating in the UK market is it represents what we refer to as the “Costco of global equities”. The Costco model is built on providing high-quality products at low prices, typically in bulk.

Beazley is one example of a global player available on the UK stock market at a discount rating relative to its prospects. The company has generated an average return on equity of 25% since 2022, has a strong balance sheet with 264% solvency capital and has returned over $1.3bn to shareholders over the past three years. Yet it traded on just 1.6X its growing tangible net asset value, a 60% discount to its eventual offer of 2.4X from Zurich Insurance Group.

Domestic energy push

The Middle East conflict has introduced a new layer of complexity. Even if a ceasefire is reached, the long-term implications are already set.

On one hand, companies are better prepared to weather this disruption due to lessons learned from COVID-19 and Ukraine. On the other, the resulting energy shock, inflation, and higher bond yields create fresh headwinds, particularly for governments entering these events with record-high debt ratios.

In public remarks, Sir Keir Starmer has tied the Iran shock directly to the case for “clean, homegrown British energy” and overall “energy independence.”

Centrica is ideally placed to be a vital private partner for the government if it wants to achieve its long-term energy market aspirations, with the company investing billions in renewables, LNG storage, regasification capacity and nuclear. The group has a net cash balance sheet and a double-digit free cash flow yield, alongside a strategic plan to double EPS and increase regulated and contracted earnings to over two-thirds of the group by the end of the decade.

As investors, admitting what you do not know is often just as important as identifying what you do. After all, conviction is about weighing up the probabilities as opposed to successfully predicting the future.

Success instead comes from consistently identifying where those probabilities are tilted in your favour. Valuation matters, both on the upside and on the downside. In uncertain times, this fundamental premise of public markets is easily forgotten. We must actively recycle capital to where the risk-reward is firmly tilted in our favour.