The UK: why so gloomy?

The FTSE All Share is hitting new highs, economic growth has been surprisingly positive and government borrowing costs are dropping. It should be a cheerful moment for UK investors after years of uncertainty and gloom. Yet sentiment towards the UK stock market remains relentlessly negative – and increasingly out of step with reality.

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The FTSE All Share has seen a significant bounce over the past three months, rising 8% to 4,751*. That puts it significantly ahead of the S&P 500, which has risen just 2.1% over the same period*. Admittedly, the arrival of Chinese AI challenger DeepSeek has dented returns from US markets, but it does hint at a change in mood.

Equally, after a period of hand-wringing about the UK economy, the latest GDP figures were cause for optimism. Economists had expected the economy to contract in the fourth quarter, and it grew – not by a lot, just 0.1%, but it was a small win at a time when every small win counts**. The economy was boosted by a stronger performance from the services sector.

There is also tentative good news on borrowing. The 10-year gilt yield had risen as high as 4.9% in early January***, prompting apocalyptic headlines about the state of the UK’s finances and the tough choices facing the Chancellor. It has now fallen back to 4.5%***, which gives Rachel Reeves some breathing space.

UK smaller companies - out of fashion

Yet the UK market remains resolutely unloved by investors. December figures from the Investment Association made for grim reading, with another £88m flowing out of UK smaller companies funds, and £553m flowing out of UK All Companies funds. The UK All Companies sector has been the worst-selling sector in eight out of the previous 12 months****.

Simon Murphy, manager of the VT Tyndall Unconstrained UK Income fund, says this gloom looks increasingly inexplicable. “This is the most attractive opportunity set I’ve seen in my career. The UK is deeply unloved. There are some wonderful valuations for some very good businesses, yet sentiment is on its knees.”

His view is that sentiment is so weak that it wouldn’t take a significant shift for it to have a meaningful impact on UK share prices. “We would also defend the outlook for the domestic economy. It is better than most people fear. And when I talk to UK companies, they say the environment is OK. The poor sentiment towards the UK is misplaced.”

Abby Glennie, manager of the abrdn UK Mid-Cap Equity fund, reports a similar picture: “The environment has got tougher, but valuations are so low that just meeting expectations is enough. While the rise in National Insurance contributions was a blow, companies have taken action in terms of headcount, and are often being more efficient. Some have even increased their prices at the same time, so are doing more with less.” She points to companies such as Telecom Plus, a utility warehouse, which is using AI to help its sales people.

The sentiment among investors stands in notable contrast to trade and private equity buyers, and to the companies themselves, who are buying like mad. 2024 was a bumper year for M&A activity. Bids for UK companies tripled. Buybacks are widespread, even among smaller companies.

Abby adds: “Buybacks were rarely a factor for smaller company investors just a few years ago, but today companies are among the biggest buyers of UK shares. That said, this is starting to ease off a little as companies have more confidence to invest in themselves.”

A range of approaches

While both managers believe that the UK is overlooked, their approach to the UK is different. Both find value among medium-sized companies, but Abby is sticking with high-quality companies, where there is no danger of nasty surprises. While the economic outlook is improving, she believes there are still potential pitfalls in areas sensitive to growth, such as recruitment.

In contrast, Simon is leaning into a better economic picture. He adds: “We have lots of exposure to the UK domestic economy. We don’t believe it’s about to go to the races, but there are great companies out there, such as Wickes and Dunelm that are doing well.”

He also has a weighting in international manufacturing companies listed in the UK. He says companies such as Vesuvius and Bodycote distribute specialist products all over the world. Manufacturing has been in the doldrums, but he is seeing signs of a pick-up, and valuations remain very low. He is keeping an eye on Donald Trump’s tariff regime, but believes the UK should be relatively well-insulated.

For investors who are more confident that the UK could turn around, the VT Tyndall Unconstrained UK Income fund would be a good choice. Or they could take a more cautious approach with the abrdn UK Mid-Cap Equity fund. For those who prefer an even more cautious approach, but one that would still participate in any improvement in sentiment, the Artemis Income fund is a good option.

Investors will have heard the cry that the UK is cheap before, only for it to get cheaper. However, the gloom on the UK stock market seems overdone. If investors start to turn away from the US mega-caps – as appears to have happened in recent weeks – the UK would only need to absorb a tiny fraction of those outflows to see a significant improvement. After all, the entire capitalisation of the UK market is now less than Apple^. A few percent coming out of Apple could really change the trajectory for the UK.

For those looking for investment ideas, our latest Viewpoint magazine is now available online and has a special feature on UK smaller companies investing.

*Source: MarketWatch, 13 February 2025
**Source: Financial Times, 13 February 2025
***Source: UK 10 year Gilt, as of 14 February 2025
****Source: Investment Association, full figures at December 2024
^Source: CEIC data, UK market capitalisation, December 2024

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.