What’s next for the UK markets?

2025 was a buoyant year for the UK stock market, with the FTSE All-Share Index delivering its strongest performance in more than a decade. It revealed a new-found confidence in UK assets and an optimism that the UK’s long run of unpopularity may finally be drawing to a close.

However, there is a caveat to the UK market’s strength. Just as in the US, across Asia and in emerging markets, returns were significantly concentrated in a handful of companies. The banking and defence sectors led the large cap index higher: banking accounted for 32% of the FTSE All-Share’s market returns and 14% was attributed to HSBC alone.

The performance from small and mid cap companies was reasonable, but they saw only around half the gains delivered by larger companies. There has also been some notable weakness among companies considered ‘AI losers’ by the market. In particular, information and market infrastructure groups such as RELX, Experian and LSEG. The launch of a range of plug-ins for Anthropic’s Claude AI tool has accelerated concerns over their business models.

To our mind, this combination of factors is creating more opportunities in the UK than headline valuations suggest. The companies that drove the market higher are unlikely to repeat that performance, and while the market has rerated, leadership has been narrow. Beneath the surface, a rotation is underway that is exposing clear valuation anomalies and rewarding more selective analysis. In this environment, future returns are less likely to come from following yesterday’s winners and more likely to be found by looking carefully under the bonnet of the market.

Valuation differential

The FTSE 250 (ex. Investment companies) Index is now trading at a higher yield than the FTSE 100 - 3.6% versus 3.0%. That has only happened a handful of times in its history. Usually, the faster-growing medium and smaller-sized companies would be expected to trade at a lower yield than their more mature and slower-growing large cap peers. It is a telling sign of the value available in this part of the market.

Investors have started to recognise this value since the start of the year, with the FTSE 250 and Small Cap indices catching up with large cap performance. We have been leaning into this shift by adding a number of holdings over the past couple of months, such as Kainos, XPS Pensions and Baltic Classifieds. There is still a lot of value in this part of the market with depressed valuations creating a rich pool of potential acquisition targets for strategic and financial buyers.

We are also adding to our UK domestic exposure, through companies such as housebuilder Taylor Wimpey or Genuit. Interest rates are falling, there is still pent-up demand and the government has been working on its planning reforms. These companies aren’t priced for any kind of recovery and we believe that may be coming in the year ahead.

‘AI losers’

The decision on some of the perceived ‘AI losers’ is more complicated. Certainly, there will be companies that face an existential threat from artificial intelligence. Given that no-one has yet quantified the reach and potential for AI, it is possible to argue that almost every company may theoretically face a threat from it. Certainly, investors have been nervous about a range of sectors that could be at risk.

However, we need to deal in fact rather than speculation. To date, we haven’t seen any sign that these companies are seeing an impact on their businesses. The companies that have seen the most significant share price falls have seen no commensurate hit to their earnings. The businesses are doing exactly what we expect. For example, Experian’s most recent update showed no sign of deceleration, leaving its full year guidance unchanged. Sage posted revenue growth ahead of expectations and also confirmed its positive outlook. If the companies keep delivering, stock prices will take care of themselves.

At the same time that the market is worrying that AI will cannibalise these companies, it is also worried that the US technology giants are not seeing a return on their vast capital investment programmes. The sell-off for companies such as RELX, which has almost halved since May 2025, or Experian, Sage or LSEG, are starting to look indiscriminate. We are not blind to the risks, but they need to be assessed rationally.

We have been discussing any potential threats with these companies for two years. Our view remains that companies with proprietary data sets, that are deeply integrated into customer workflows and decision making, are in a powerful position. RELX, for example, was quick to come out with a range of generative AI products, leveraging its proprietary content. Anthropic, for all its strengths, cannot replicate the 160 billion documents RELX has on its database. All these businesses have good customer relationships, recurring revenues and long-term contracts supporting attractive revenue visibility over time.

Market volatility

Markets are noisy. At the other end of the scale, we have seen one our largest holdings – ASML – more than double since summer 2025. Chesnara, M&G, Genus and Oxford Instruments have also seen strong gains. Elsewhere in global stock markets, we have seen huge rises and falls in the precious metals markets, the US megacaps and, bitcoin. There’s a lot of movement in financial market prices with vast enthusiasm and pessimism all at once. Within this environment, it is important to be clear-eyed about a company’s prospects.

Today, we see growing momentum behind the view that there are other places to invest beyond US equities. This is welcome news for overlooked markets such as the UK and for its small and mid cap segments sectors in particular. It has a wealth of opportunity for active investors.  

Important information

Risk factors you should consider prior to investing:

Other important information: 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.

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

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