The UK Budget: 100 days on

Last November’s Budget appeared to set the stage for a more positive outlook for UK equities. The Chancellor built herself some room to manoeuvre and tax hikes were not as severe as feared. The gilt market was tamed, and bond yields started to drop. There was a sense that the UK may be about to turn a corner.

The Iran conflict has thrown a spanner in the works. Iran has blocked the all-important Strait of Hormuz, a crucial shipping lane for fossil fuels coming out of the Middle East. The oil price has spiked, along with gas and other commodities, with potential knock-on consequences for UK inflation. The turmoil has hit UK borrowing costs, with the gilt yield spiking higher as investors anticipate higher interest rates.

The situation remains fluid, and the ultimate outcome depends on how long the Strait remains closed. It is plausible that some international coalition will be agreed to keep the lane open, but even if this is agreed, oil price spikes could last for six weeks. Aberdeen’s Deputy Chief Economist Luke Bartholomew says every 10% increase in oil tends to be associated with a 0.2% increase in headline inflation at global level. A temporary closure is likely to add 0.5% to headline inflation this year.

For the UK, he says, it may defer some of the tentative signs of recovery. At the start of 2026, PMI surveys had started to look stronger, and retail sales suggested a more confident consumer. Bartholomew says it is likely that inflation may fall to 2% and then rise higher again as the oil price shock is reflected in household bills. The Bank of England will almost certainly wait to lower rates, though the ultimate path is likely to be lower – the fundamentals of the UK economy need lower rates.

A change of government remains a risk in the UK, he says. Chancellor Reeves has rebuilt some credibility with the gilt market. If the current government were to be replaced with one more open to deficit-financed spending increases, there could be dangers for the UK economy. This is an ongoing area of concern.

Nevertheless, there are some reasons to temper pessimism around the UK economy. If the oil disruption is temporary, it is likely to defer rather than cancel interest rate cuts. A cut in April is still possible. And household balance sheets are very strong, with plenty of savings, so have some resilience.

UK stock market: opportunities for active stock pickers

Just as the problems in the Middle East have disrupted a developing recovery in the UK economy, they have also dented UK stock markets. 2025 was a strong year for the FTSE 100, and this strength was broadening out into smaller and medium-sized companies when the attacks were launched. The problem has been that sentiment towards this part of the market has correlated with UK borrowing costs. Higher gilt yields have hurt.

However, across the UK market there are real opportunities for active stock pickers. In the Aberdeen Equity Income Trust, for example, investors’ new-found enthusiasm for companies with strong asset backing has provided a boost. This type of company is a natural hunting ground for Manager Thomas Moore, who seeks out companies with strong cash flows, who can then pay that money to shareholders in the form of dividends.

Many of the companies in the trust’s portfolio are insulated from the potential disruption of Middle East tensions. Rio Tinto, for example, is supported by the strength of global commodities demand, as is BP, while HSBC may be a beneficiary of higher-for-longer interest rates. BAT and Imperial Brands are also seeing strong cash flow and high dividend payouts.

It is possible to find defensive options among smaller companies as well. Amanda Yeaman, Co-Manager of the Aberdeen UK Smaller Companies Growth Trust, says they always look for companies that are in charge of their own destiny rather than in thrall to the strength – or otherwise – of the UK economy. She says there are a range of undervalued companies showing real strength.

Areas of resilience

The small cap team are finding a range of infrastructure companies, for example, that are beneficiaries of government spending likely to span multiple years. That might be in transport, energy or water, but they have predictability of demand. These include companies such as Balfour Beatty, Morgan Sindall and Galliford Try. These are businesses where demand isn’t likely to dry up if the economy softens. They have predictable cash flows and resilient revenues. The trust also has some oil and gas exposure, and some exposure to defence companies, such as Avon Technologies and Chemring.

Rebecca Maclean, Co-Manager of the Dunedin Income Growth Investment Trust, says the UK market still holds plenty of dividend opportunities as well. The team finds plenty of companies that can grow their dividend sustainably, such as Chesnara, which has built a multi-decade track record of paying and growing its dividend. Or NatWest, which has an attractive yield. The trust also holds TotalEnergies, which is providing some ballast as oil price volatility continues.

But one of the greatest defences open to fund managers is understanding the companies in depth, the risks to their businesses, not just from the war in the Middle East, but more widely. For example, Maclean has been working to quantify the impact of AI on the companies held in the portfolio. She is speaking to management teams about their ‘moat’, and the extent to which they are going to be able to grow in a new AI environment. Are they investing enough to be ready for AI? Have they got financial resilience? This has helped her build conviction in certain areas and she has used share price volatility to top up positions.

The UK’s Achilles heel is also its superpower. Valuations remain low in the UK market, relative to other markets and to their own history. By itself, that delivers some protection. In this type of environment, high expectations can be a significant risk.

The US is now a huge part of most investors’ portfolios, while the UK has been sold down over time. Embedded expectations for the US are high, and it is reliant on the uncertain outcomes of artificial intelligence. The opposite is true for the UK. The UK stock market provides a different type of exposure, and some real diversification potential from the US. In difficult conditions, that may become more important.

Important information

Risk factors you should consider prior to investing:   

The Aberdeen Equity Income Trust Key Information Document can be obtained here.

The Aberdeen UK Smaller Companies Growth Trust Key Information Document can be obtained here.

The Dunedin Income Growth Investment Trust Key Information Document can be obtained here.

Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG, authorised and regulated by the Financial Conduct Authority in the UK.

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