UK Budget 2025: Could It Boost UK Equities and Small Cap Stocks?
The Budget – Friend or Foe for UK Equities?
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21 Nov, 2025
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The Budget – Friend or Foe for UK Equities?
The 2025 Budget is finally behind us. It had been the source of relentless speculation, with rumours of bold new tax rises and spending cuts, including a potential rise in income tax that was subsequently rejected. This has been an unhelpful backdrop for sentiment towards UK equities, particularly domestic small and mid cap companies. Nevertheless, while many of the measures were unpopular, there is a chance that it could prove a galvanising event now that investors have more certainty.
FTSE 100 Outperforms While UK Small Caps Struggle in 2025
The UK stock market has been running at two speeds in 2025. On the one hand, the FTSE 100 has been a source of strong returns for investors, up 21% in total returns for the year to date (to 20 November)[1], even outpacing the S&P 500 USD[2], with some of its flagship companies delivering double digit returns. However, it has been a different story for the UK’s mid and small-caps.
The rally in the FTSE 100 appears to have been driven by international investors looking to diversify away from the US technology sector.
These investors are looking at the top end of the UK market and they can find lots of attractive situations. They are looking for international companies with good global market positions and in the UK, they can find them at a massive discount to elsewhere.
The market has been led by companies such as Rolls-Royce, BAE Systems and a number of the banking groups. Noffke points out that the five year total return for the FTSE 100 is 80% (to 20 November)[3].
In contrast, the UK’s small and mid-cap companies have lagged on worries over domestic economic growth. Here, the budget has proved a significant drag, with speculation over tax rises deterring UK retail investors and preventing UK companies from making decisions on hiring and investment. This has compounded long-term outflows from UK equities from UK domestic investors. Calastone flow data shows £1.22bn outflows from UK funds in October alone[4].
Noffke believes that last year’s budget may also be weighing on this part of the market.
(Small and mid caps) have delivered reasonable returns in absolute terms, but they have lagged larger company performance. The fear factor has weighed on the valuations of small and mid-sized companies. Domestic investors – who typically held quite a lot of exposure – have been selling down to buy international equities.
She believes it takes time for investors to change their minds.
Allocators tend to look in the rear view mirror and at a 10 year return. Areas such as the UK, emerging markets Asia, have all underperformed the high flying but expensively valued US equity market over 10 years, but if you cut it on five years, the difference is not as extreme. It is about trying to challenge those assumptions.
What to Expect from Rachel Reeves' November Budget
The budget has been a source of extraordinary speculation, briefing, and counter-briefing. The Chancellor is thought to have considered more than 100 tax and spending plans [5], many of which have been reported as a racing certainty by an alarmist media. While some tax rises were inevitable after a downgrade in productivity from the Office for Budget Responsibility, the final outcome is difficult but not disastrous.
There was some reprieve for the Chancellor on government borrowing. The OBR has estimated that the gap in public finances is around £10bn lower than original estimates[6]. Gilt yields have come down since the start of September, in spite of concerns over the Budget, and came down again in its immediate aftermath. UK economic growth, while not impressive, is forecast to be the second highest in the G7 this year[7].
UK Small and Mid Caps Trading at Rock-Bottom Valuations Despite Strong Earnings
Overall, the fears over the UK’s prospects look overblown and this has been reflected in rock bottom valuations, says Jean Roche, manager on the Schroder UK Mid-Cap fund:
The valuations just look wrong. Many other markets have been beneficiaries of the diversification trade away from US assets, but not this one.
Small and mid-caps look even cheaper than they did a year ago, as earnings have outpaced share price growth. This is particularly evident in the yield, now higher for the FTSE 250 and Small Cap indices than for the traditionally higher income FTSE 100. The level of buybacks are also noteworthy, with Roche saying the UK is now the ‘buyback king’. The combined buyback and dividend yield for the FTSE 250 is 5.4%, around 50% greater than the S&P 500.
The UK’s low valuations have caught the attention of international investors, particularly private equity buyers. The Schroder UK Mid-Cap fund has had bids for two of its holdings at 75%+ premia to the prevailing share price.
This is what happens when you have world class assets going at bargain basement prices... Something will close the gap, and at the moment, it’s merger and acquisition activity.
A Relief Rally in UK Equities?
Given the overall pessimism in the UK market. It won’t take a significant shift in sentiment for share prices to move quite strongly. With some certainty on UK tax and spending, the Budget may prove a galvanising event.
Roche is optimistic:
People will have a better idea on the rules of the game. If you’re looking for breadcrumbs: housebuilding is something the government is still sticking with, for example and a natural place where we expect to see support.
It is the domestically focused companies that have been hit hardest by budget speculation, and it is these areas that could rally most should the budget not turn out as bad as expected.
Positioning
Both fund managers are focused on companies that can grow earnings, whatever the economic weather. Roche points to food producer Cranswick.
It uses its cash flow wisely, reinvesting it in its own businesses, as well as paying a dividend.
She also likes Telecom Plus, which currently has a 3% share of the UK energy market. The management team has said it wants to grow its user base from one million to two million over five years and is well on the way to achieving its goal. She likes its multi-level marketing model. The UK consumer sector is still tough and competitive, says Roche, but the fund holds UK homewares leader Dunelm. It has delivered high returns on capital, paid special dividends, and is very tightly managed by a skilled team.
Noffke holds around three-quarters of her portfolio in FTSE 100 stocks, with the remainder in mid and small caps. Like Roche, she also holds Cranswick and Telecom Plus. She says she can still find a number of large-cap stocks in spite of the recent rally, but admits that the yield available on mid-caps is appealing.
It tells you how stressed some of the relative valuations are and we think there is more room to grow.
Among Schroder Income Growth Fund holdings is Hollywood Bowl, which has suffered through the recent bout of good weather (people prefer to go bowling in bad weather). It now looks very good value, says Noffke, and she likes its Canadian franchise. Within the trust’s recent financial year (ended 31 August 2025), Sue also bought more Burberry. Drinks maker Fever Tree is another recent purchase, where she is encouraged by its recent tie up with Molson Coors.
Why UK Equities Offer Diversification from Overvalued US Tech Stocks
SMID pedigree
Roche points out that mid-caps have an enviable pedigree, with a history of delivering returns in line with the S&P 500. They are often in the sweet spot for growth, not too small to be vulnerable and not too large to be cumbersome. The current valuations look anomalous, and the gloom on the UK is out of step with reality. The Budget could be a moment when investors start to question why they have been so pessimistic.
There is a final consideration for investors contemplating moving back into the UK market. At a time when the US markets are looking increasingly expensive, and diversification is becoming more important, the UK market looks like a perfect foil to the tech-heavy S&P 500. Expectations are low, and the sector makeup brings balance to a portfolio.
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[1] Schroders, 20 November 2025
[2] MarketWatch S&P 500 Index, November 2025
[3] Schroders, 20 November 2025
[4] Calastone, November 2025
[5] Independent, November 2025
[6] BBC, November 2025
[7] BBC, October 2025
