The unloved UK market has seen a revival in recent months as investors have looked to counterbalance the AI trade.
- The FTSE 100, 250 and SmallCap indices have all seen strength amid the recent volatility
- The FTSE 100’s ‘old economy’ flavour has served it well amid AI volatility
- An improvement in the UK economy may have been influential
The UK stock market is having a moment. As the US and Asia markets have been buffeted by fears over the AI trade, the FTSE 100, 250 and SmallCap indices have been gliding quietly higher. It marks a notable turnaround for the unloved UK, but it’s been a long time coming.
It is perhaps easy to see why the FTSE 100 has found favour. Its ‘old economy’ flavour has looked like a safe haven when there has been considerable uncertainty about some parts of the ‘new’ economy. It has almost no direct technology exposure, making it a natural source of diversification as fears have mounted over AI. It still has an attractive yield and valuations remain low.
It is tougher to see an immediate catalyst for the small- and mid-cap bounce. Shares are cheap, but they have been cheap for a long time. Also, small- and mid-cap companies are usually vulnerable to hikes in borrowing costs and gilt yields are at 20-year highs. It is not a natural backdrop for small and mid-caps to make progress.
A possible catalyst is the better news emerging on the UK economy, with growth revised higher. In its latest World Economic Outlook, the IMF forecast UK GDP at 1.3% in 2026 – an upgrade of 0.5 percentage points. That puts it as the second-fastest growth in the G7, alongside Germany.
Consumers have finally started spending, reducing their previously high savings rates. The savings ratio had been hovering around 10%, an historic high, but has dropped back to 9%. Equally, the Chancellor has managed to avoid much of the damaging speculation around the budget that weighed on UK stock markets last year. Ruling out a capital gains tax rise was also useful.
There has also been a surge in merger and acquisition activity. Tate & Lyle, easyJet, Senior, Gamma Communications and Spire Healthcare have all seen bids, alongside UK retirement specialist Just Group, plus Spectris and Bodycote. Most of these bids have been at a significant premium to the previous share price. This has put a floor under valuations.
Perhaps, as a number of small cap managers have suggested, catalysts are only really evident in hindsight. The small- and mid-cap sectors just got too cheap and have started to capture the attention of international buyers looking for a bargain. The UK may also have a useful role as a port in the storm of the AI trade.
