As part of today’s special feature “Where Next for UK Equities?” investment and market experts are sharing their views on valuations, opportunities and what could drive the next phase for UK stocks. In this Q&A, Michael Browne, Senior Investment Strategist, Franklin Templeton Institute, shares his current thinking on market conditions, risks and opportunities that are facing the UK equities sector at the moment, and some of the areas where he is seeing particular value
What is the current situation on the stock market for British companies? Which factors play the most important role / what has led to this development?
When it comes to the UK stock market, it’s essential to consider it in two distinct parts. Firstly, you have the FTSE 100, where 82% of sales are generated outside the UK. This is dominated by global heavyweights such as HSBC, BP, and Astra Zeneca. These international powerhouses have helped the FTSE 100 deliver steady returns, both in terms of capital growth and dividend income.
In contrast, the picture looks quite different below the FTSE 100. The FTSE 250 Mid-Caps and the small-cap index have experienced a rollercoaster ride, with performance influenced by government policies on taxes and inflation. While the FTSE 100 has jogged along with quiet consistency, the Mid-Caps and small-caps have been more volatile, making them more sensitive to changes in UK interest rates.
One of the key factors contributing to this volatility has been the long-term selling by UK pension funds from the domestic market where weighting today is as low as 3.5% of their equity portfolio. This trend has been exacerbated by recent government policies, including the 2025 budget’s inflationary measures. As a result, the number of initial public offerings (IPOs) has dried up, but merger and acquisition (M&A) activity has surged, driven in part by low valuations.
Despite these challenges, this Mid and Small cap segment of the market remains highly responsive to changes in UK interest rates. While the Bank of England’s recent decision to keep rates on hold may have disappointed some, it’s essential to remember that this sensitivity also presents opportunities for the future. As the UK economy continues to evolve, investors would do well to keep a close eye on this often-overlooked corner of the market
How do you currently rate the FTSE 100?
The FTSE 100 emerges as a barometer of the world economy. This is particularly evident in the index’s recent performance, which has been driven by a mix of global growth catalysts.
One of the key drivers of this momentum has been the mining sector, which has benefited from increasing confidence in the US and Chinese recoveries. The sector’s exposure to these two economic powerhouses has positioned it well for growth. Banks have also ridden the wave of optimism, especially as they are a beneficiary of high local interest rates.
Another sector well-placed for long-term growth is defence. With both the UK and European governments committing to increased defence spending, FTSE 100 defence stocks are poised to reap the rewards.
The pharmaceuticals sector has had a more turbulent time, buffeted by headwinds from the US. However, beneath the surface, there are opportunities for growth over the next five years, driven by a pipeline of innovative products and a favourable demographic profile.
The FTSE 100’s consumer staples sector is another area of strength, home to European retailing giants such as the continent’s largest food retailer and one of the most profitable clothing retailers. These companies’ skill and efficiency and stable cashflows make them attractive propositions in uncertain times.
So, why have UK equities, including the FTSE 100, been shunned by investors? The answer lies in a combination of factors, including a lingering dislike of UK equities among domestic and international investors, as well as a dash of Brexit-related uncertainty. However, this has created a buying opportunity of rare proportions, with many FTSE 100 stocks trading at historically low valuations.
As we look to 2026, we expect international growth to be upgraded, which should provide a tailwind for the FTSE 100. If UK interest rates fall further, as we anticipate, the UK-sensitive sectors could lead the charge for the first time in several years, making now a compelling time to take a fresh look at the index
Apart from that, what are the biggest opportunities and risks for the UK economy and, from an investor’s perspective, for British stocks?
The UK’s budget, on 26th November, is just around the corner, and it’s shaping up to be a make-or-break moment for investors. With a debt-to-GDP ratio of over 90%, tax revenue shortfalls, and £6bn of welfare spending cuts blocked in Parliament, the Government is staring into a fiscal abyss. The question on everyone’s lips is: what’s the plan to get the country’s finances back on track?
Chancellor Rachel Reeves finds herself between a rock and a hard place. Having ruled out hiking income tax, VAT, or corporation tax – which together account for 70% of all tax revenue – she’s left with limited options. The markets are clear: the Government needs to demonstrate its commitment to fiscal discipline, and fast. That means either raising taxes or cutting spending. But with the latter option looking increasingly unlikely for this Cabinet, the Chancellor may have no choice but to reach for the tax lever.
The stakes couldn’t be higher for the Chancellor. She will need to pull off the impossible – finding non-inflationary tax rises that the markets believe will work. UK interest rates are currently 120 basis points higher than those in France, which is rated one notch lower by the credit agencies. Closing this credibility gap could halve that premium, leading to lower interest rates, which in turn would give the economy a much-needed boost. And with a rising pound sterling likely to follow, lowering inflation further, UK assets could become a haven for investors once again.
But if the Chancellor fails to deliver, the consequences will be severe. UK interest rates could soar, making it even more expensive for the Government to borrow, and pushing the economy further into the red. The markets have a way of imposing financial discipline, and they will not hesitate to do so if they lose confidence in the Government’s ability to manage its finances. It could be a very difficult Christmas and threaten the future of not only the Chancellor but the Prime Minister as well.
So, what’s an investor to do? The answer is simple: do you trust the Chancellor to regain credibility, or not? If you believe she can pull it off, now may be a good time to buy into UK assets. But if you’re not so sure, it might be wiser to wait and see how events unfold. Either way, you still buy!
How is US policy affecting the UK economy and stock market?
The UK economy has so far weathered the US-China trade war with surprising ease. A key factor has been the early agreement on tariffs, which secured preferential rates for UK exporters. This has been particularly beneficial for the car industry, which managed to negotiate a unique deal that protects current exports to the US.
Not all UK sectors have been immune to the trade tensions, however. UK steel, for example, has suffered along with other US-bound exporters, but its relatively small contribution to the overall economy has limited the damage.
The UK’s pharmaceutical industry, with its extensive US operations, has been shielded from the worst of the tariffs, while the rapidly growing software and gaming sector, which is heavily represented in the FTSE 250 and Small Cap indices, has continued to thrive, largely unaffected by the trade tensions.
To round this off Michael, which sectors are you finding particularly exciting in the UK right now? And which individual stocks do you believe are currently attractively valued?
The UK software sector is a hidden gem, offering a unique combination of attractive valuations, a deep pool of innovative companies, and a strong track record of M&A activity. With a decade-long record as Europe’s largest investor in AI, the UK is punching above its weight in this field.
The UK’s lead in offshore wind farm development will also drive growth in data centres, once pricing and transmission issues are resolved. And with its bridge-like position between Europe and the US, the UK is perfectly placed to attract investment, talent, and customers from across the Atlantic.
