The Viewpoint: UK stocks and the 12 days of Christmas

Many happy December evenings have been spent gathered around the Christmas tree, blaring out this traditional English carol. It tells the story of the increasingly numerous gifts given to the speaker by ‘their true love’.

Christmas is not only a time to reflect on the year just passed but also a time to think about shaping the opportunities in the year ahead.

As we’re now in the run-up to Christmas, I thought I might also be allowed 12 wishes for the UK stock market…

1. Growth to reaccelerate. Corporate earnings growth has been a rare commodity in recent years as investors battled higher costs, Covid-induced destocking, rising interest rates and geopolitical uncertainty. The slower growth environment has led to a re-evaluation of traditional valuation multiples and the outperformance of ‘value’ investing. The result is stocks that previously might have been classed as ‘growth’ names are now on what we see as exceptionally attractive valuations and many of these growth headwinds appear to be behind us.

Stocks that previously might have been classed as ‘growth’ names are now on what we see as exceptionally attractive valuations.

2. A return to investing on the basis of fundamentals. We believe that it is the fundamental qualities of businesses that drive earnings and earnings drive stock prices. However, over the last three years, UK stock market performance has been dominated by macroeconomic and geopolitical headlines; the strong negative correlation between the 10-year gilt yield and the performance of the FTSE 250 Index is just one example. Kenneth Galbraith famously said, ‘There are two kinds of forecasters: those who don’t know and those who don’t know they don’t know.’ We look forward to a return to stock-picking on the basis of ‘fundamentals’!

3. A focus on long-term investing vs short-term trading. Benjamin Graham referred to the stock market as a ‘voting machine’ in the short term and a ‘weighing machine’ in the long term. Indeed, short-term ‘price momentum’ as a style factor has been one of the major driving forces behind stock performance this year. It is notoriously difficult to add value over the long term by trading. Therefore, a strategy that involves allowing the capital of high-quality companies to compound over the long term at the highest possible rate with minimum amount of risk would seem preferable.

4. UK Equity Inflows. Four years of UK equity outflows has led to significant distortions and inefficiencies in equity market pricing, particularly in the small and mid-cap universe. The reasons for these technical headwinds are well versed but include the strong performance of US markets and UK pension funds/institutions reducing their UK equity allocations in favour of other geographies or private equity/credit. Indeed, UK defined contribution pension funds now allocate less than 5% of their total assets to UK equities (from c. 40% a decade ago). Clearly this can’t continue for ever and at times when outflows have slowed, the UK market has responded very positively!

5. Broader market performance. Stock market performance across the globe has been extremely concentrated and generally favoured a small number of larger companies. The well publicised ‘Magnificent seven’ technology companies have dominated US returns such that their combined market capitalisation is now bigger than the UK, Canada and Japanese stock markets put together! In the UK, there are fewer directly exposed AI ‘winners’ but defence and financials sectors have been key drivers of returns. Indeed, Rolls Royce, HSBC and Barclays have accounted for c. 40% of FTSE gains over the last two years. A broader market in terms of sector and stock contributions to returns would certainly be a healthier sign for equity markets.

6. An end to trade wars. The trade barriers implemented by Trump this year have in many cases been extreme in size (145% on China in April!), unpredictable in nature and timing, and have increased the cost and complexity of cross border trading. Corporates and consumers have had to digest the direct and indirect impact of these higher costs, with implications on demand and corporate profitability. Some of these tariffs have been rolled back or subsequently lowered but many still remain in place and as such restrict free trade.

7. A government that supports our capital markets. Measures to support our capital markets are needed urgently because of the wider benefits capital markets bring to the UK economy, including employment, economic growth, investment and of course tax revenues. UK focused ISAs, pension investment reform, a sovereign wealth fund and scrapping stamp duty are all ideas that have been touted and while there is likely no single bullet, some action is required to reverse recent de-equitisation.

8. M&A activity to act as a catalyst. This year there have been over 40 bids for UK public companies with a market capitalisation of over £100mn and the average premium to the undisturbed price has been over 40%. This has come from a mix of corporates (70%) and financial buyers (30%) and overseas bidders have represented 61% of total activity. Elevated M&A activity looks set to continue while UK valuations remain so depressed and while this sadly reduces the universe of listed companies, it can secure attractive short-term returns. Furthermore, we hope it is likely to catalyse a broader positive reappraisal of the market and company valuations.

Elevated M&A activity looks set to continue while UK valuations remain so depressed.

9. Refresh of the universe. Since 2021, the UK market has been exceptionally quiet in terms of IPOs but activity appears to be picking up and this year there has been a flurry of new companies coming to the UK mid-market. For instance, Shawbrook, the specialist lender, recently listed with a valuation of just under £2bn. This is essential to ensure the health of the stock market which ultimately acts as a funding mechanism, enabling companies to grow, scale and hopefully remain in the UK!

10. Lower inflation & interest rates would be helpful. Inflation has remained stubbornly high since Covid (made worse by the recent increase to employer National Insurance Contributions). Not only has this put pressure on corporate cost bases but it has also kept interest rates higher for longer. Higher interest rates mean higher funding costs for companies, slowing investment and expansion. Higher discount rates also put pressure on stock market valuations by more heavily discounting future corporate cashflows. Lower interest rates would be another helpful catalyst for growth.

11. A seamless process for AIM to Main list transitions. Following the Chancellor’s changes made to Business Property Relief in the Autumn 2024 budget, many smaller companies have chosen to shift their stock listing from the Alternative Investment Market (AIM) to the Full List. While this transition should improve liquidity and corporate governance, the process comes with a significant short-term challenge as investors focused on their potential inheritance tax (who in some cases might be up to 30% of the shareholder register) are forced to divest. This has created some technical headwinds to stock performance and has been particularly marked when the transition process has either been elongated or uncertain.

12. Small and mid-cap outperformance. UK small and mid-cap companies have historically delivered far superior returns to their larger peers, but the recent past has been more challenging for reasons outlined above (many of which are technical). This asset class is deeply discounted on most valuation metrics and as Warren Buffet said, ‘Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble’.

As Warren Buffet said, ‘Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble’.

It has certainly been an eventful 2025 for fund managers and investors alike and we look forward to what 2026 brings.

We hope that all your Christmas wishes come true!

For professional investors only. This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.