The woes of the UK stock market have been well-documented. While 2025 has seen a notable rally in the FTSE 100, small and mid-cap stocks have continued to lag.

This time, the speculation around the Budget appears to be to blame, with investors worried about tax rises and fiscal black holes. However, there is a chance that the Budget could be just the spur the UK stock market needs.

This sounds implausible. The UK’s fiscal position is tricky and downgrades to productivity estimates could make the situation even worse. Economic growth is anaemic, even though recent inflation and retail sales data have been more encouraging. There has been some reprieve from bond markets, with the UK 10-year gilt dropping from 4.75 per cent to 4.5 per cent over the past few weeks, but not enough to make a fundamental difference to the chancellor’s sums.

However, all this negativity may make a bounce more likely. Speculation around tax rises in the Budget has been unhelpful for the UK stock market, knocking confidence and deterring investors.

Abby Glennie, manager of the Abrdn UK Mid-Cap Equity fund, says: “The people who are most negative on UK equities are actually UK-based investors. Picking up the newspapers, seeing the headlines, counting down the days until the Budget — that makes people quite focused on the negative aspects of the UK market.”

Among the tax rises apparently under consideration are changes to the treatment of partnership income for doctors and lawyers, changes to the tax-free allowances for pensions, increases in inheritance and capital gains tax, windfall taxes on banks and/or gambling companies, and changes to national insurance. While the chancellor may pick one or two of these options, she is unlikely to pick all of them. As such, a gap is opening up between expectation and reality.

Simon Murphy, manager on the VT Tyndall Unconstrained UK Income fund, says: “I’m not trying to argue if the economy is in incredibly robust shape, but it may be more resilient than the very negative perception out there. That’s what’s creating the opportunity.

“There needs to be a little bit of perspective. I talk to a lot of companies on a daily basis and most of the companies I speak to in the UK today, even the very domestically-focused companies, are saying it’s not fantastic out there, but actually it’s still not that bad.”

He says that, given this pessimism, there is a reasonable chance that the fear ends up being worse than the reality. “We will see some tax increases, but they may be less aggressive than people fear. Stock markets are all about what is priced in. So if, at the margin, whatever the government chooses to do in the Budget is less draconian than we’re all worried about, the stock market will take that in a positive way.”

This would be particularly evident in the small and mid-cap companies, which have borne the brunt of flagging confidence in the UK economy.

Glennie contrasts the views of domestic investors with those of global investors, who are enthusiastically buying up UK companies: “They’ve looked at the value opportunity, they’ve looked at how unloved and undervalued these companies are, and are coming in and bidding for them. We’re seeing that happen at attractive premiums to their current share price. If UK investors won’t re-rate them, others will.”

The UK market also has a high dividend yield. Crucially, the yield for the FTSE 250 and FTSE Small-Cap sectors is higher than for the FTSE 100. Companies are also buying back their own shares — a sign of confidence in their businesses. This means that the ‘all in’ yield (dividends plus buybacks) compares favourably to both its history and to other markets. This means investors do not have to do very much to achieve a high return and the risks are relatively low.

More importantly, at a time when many parts of global stock markets look highly priced, UK valuations are undemanding. Glennie says: “It is this combination of your potential return, and the price you’re paying for it, that’s where the opportunity lies.” She points out that the valuation of the FTSE 250 is almost half that of the S&P 500.

Alexandra Jackson, manager of the Rathbone UK Opportunities fund, agrees that the UK’s perceived weaknesses may be its strength. It has low price-to-earnings multiples, and yet “a rich mix of global earnings”. The UK may also be an outlier in having faced up to its fiscal challenges head-on. The same cannot be said for the US, France or Japan.

She adds: “Risks remain, particularly from public finances and inflation surprises, but we believe much of the gloom is already priced in. A modest improvement in confidence, whether through fiscal policy, earnings or broader sentiment, could prove enough to extend the current momentum. Investors have grown used to overlooking the UK. But that may be precisely why the opportunity now is so compelling.”

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