Does the disconnect between the UK economy and the UK equity market matter?
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The UK economy: how has outlook changed?
Over recent years, the US equity market has become an increasingly high proportion of passive market cap equity portfolios. The US equity market itself is dominated by a handful of very large tech stocks, whose valuations have increased at dizzying rates. Against this backdrop, many of our clients have been considering the regional allocation of their equity portfolio.
In this article, we consider specifically the divergence between the performance of UK equities, and how this differs from that of the UK economy. We examine what is driving this disconnect and what it means for investors.
The UK economy: challenged
The UK economy has experienced a challenging decade, especially since the pandemic. The reality has been modest momentum in 2026, with not much room for error.
This is partly due to the conflict in the Middle East, which has thrown everything into the air. Higher energy prices have stuck since the conflict ignited and have continued to be volatile. While inflation slowed to 2.8% for the 12 months to April 2026, it is expected to rise as elevated energy prices pass through. In addition, stimulus previously anticipated from more accommodative Bank of England monetary policy has been thwarted by a rates being held at 3.75%. This places yet more pressure on the economy and the UK’s precarious fiscal position.
Growth: Momentum since the pandemic has been weak, reflecting a range of structural issues such as an ageing population, labour supply constraints and weak productivity. UK economic growth continues to trail that of the US, aligning more closely with other major European economies – although forecasters are expecting some improvements in 2027.
Inflation: Inflation in the UK has been more persistent than elsewhere, with progress slowing due to “sticky” core services inflation linked to previously strong wage growth — although these pressures have begun to ease. Prior to the escalation of the Middle East conflict, forecasts for 2026–2027 pointed to a meaningful slowdown in inflation. This would have given the Bank of England scope to lower interest rates, supporting investment and medium-term growth.
While headline inflation has slowed slightly, the recent improvement is less reassuring than it first appears. The April figure, for example, was supported by lower household energy prices, reflecting the Ofgem price cap assessment period running from mid-November 2025 to mid-February 2026 — before the conflict began.
Since then, inflation expectations have moved higher again, and the outlook remains highly sensitive to the path of energy prices, particularly gas. In that sense, there are echoes of previous inflation shocks.
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UK equities: stellar
But, even if the UK economy suffers, does it really matter, as far as the UK stock market is concerned?
Despite a sluggish domestic economy, UK equities still delivered strong absolute returns. The MSCI UK Index returned 23% on a total return basis over 12 months to the end of May and was up 6.8% year to date.
The relative comparison to developed peers appeared less rosy than earlier in the year. The strongest phase of relative outperformance came earlier in 2026 but by end-May some of that momentum had faded. The UK lagged the MSCI USA Index which returned 28% in GBP terms, as US technology earnings have bolstered returns, but still outperformed the MSCI Europe ex UK Index by 4%.
Why the divergence?
The UK equity market is driven by the economy; it’s just that it’s not the UK economy that’s doing the driving.
It is driven by overseas earnings…
It is driven by overseas earnings...
Much of the UK stock market is more sensitive to the global economic picture rather than the UK outlook. This is particularly true for large‑cap companies: about 75% of FTSE 100 revenues are generated overseas, compared to around 40% of US S&P 500 revenues. Thus Sterling weakness boosts the value of multinational earnings when translated back into Pounds, lifting performance – as we saw when the currency fell ahead of the Autumn Budget.
As you might expect, UK mid- and small- cap companies rely more on domestic activity and more closely reflect UK economic conditions – but they only make up a small proportion of the UK market. The FTSE 100 represents around 80% of the London Stock Exchange’s capitalisation, therefore dominating overall market performance.
...and old economy sectors
The UK equity market is commonly seen as having an ‘old economy’ bias: try naming the top 10 (or 5?) UK tech stocks which differs from the broader UK economy. The chart highlights the sector composition of the FTSE 100.
At the large‑cap level, the UK remains heavily concentrated in financials, consumer staples, healthcare, energy and mining. This is a very different profile to the 70%+ services‑based UK economy, with financial services being the main (partial) exception.
The contrast with the US market is stark. The huge rise in the new- or at least newer-age technology, biotech and digital sectors, now represent a larger share of both the stock market and US GDP – estimated to be close to a third of both if you include the economic impact of productivity improvements driven by these sectors.
So why hasn’t the UK equity market evolved?
Several structural and behavioural factors have contributed to the UK equity market’s limited evolution:
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- UK initial public offerings (IPOs) – ie private companies listing on the UK public market - have been very low for some time. Companies are staying private for longer, and often choosing to list elsewhere when they do so.
- During 2025, UK IPO activity picked up slightly, with 23 companies listing on the London Stock Exchange (up from 18 in 2024). But the overall number of both UK and international companies choosing to list in the UK, and being listed in the UK, has steadily declined over the last decade. EY reported just two UK listings in Q1 2026.
- The government is seeking to remove barriers to UK listing, and we note that a three-year tax relief from the 0.5% stamp duty charge was announced in the Autumn Budget for companies listing in the UK for the first time. While that is welcome, the narrow scope may have a limited impact overall.
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- A long‑standing valuation discount relative to global peers, particularly US equities, has become increasingly self‑reinforcing, limiting the UK’s coverage, liquidity and opportunities for scale.
- At the same time, deeper capital pools and broader sector exposure in the US continues to draw both investors and UK‑listed companies abroad – particularly tech companies, who commonly choose to head for the States.
- Notable examples include the UK semiconductor and software company Arm Holdings which chose to list on the US NASDAQ exchange in 2023 despite heavy lobbying to list in London, and one of the UK’s largest fintech businesses, Wise, announced its US listing on NASDAQ on 11 May 2026, although maintains a secondary listing in London.
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UK investors have increasingly shifted toward global, market‑cap‑weighted strategies, reducing the natural domestic buyer base for UK-listed equities.
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Large institutional investors (particularly DB pension schemes) have also re-balanced their portfolios in recent years, with many reducing equity allocations as part of broader de‑risking and asset allocation changes.
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In 2024, the DWP estimated that the proportion of UK equities in DB private pension equity portfolios had fallen by over 20% in the last 10 years, comprising just 11% in 2023. Even that materially reduced allocation still reflects a home bias, significantly above the UK’s ~4% weighting in the global market.
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- While there is a sense that every American (and increasingly Chinese) start up wants to rule the world, UK start-ups may be happy to settle for much less.
- UK entrepreneurs wishing to grow are not helped by the relatively small size of the addressable domestic market. Expanding into overseas markets is not easy. US and Chinese firms have the advantage of being able to grow many times bigger (and financially and commercially stronger) that their UK equivalents before having to face that challenge.
- The availability of capital to companies across all phases of their growth trajectory can be patchy in the UK, in contrast to the deep private market funds accessible in the US and the combination of private and public funds on tap in China.
Collectively, these dynamics have slowed the natural evolution of the UK equity market. With fewer domestic buyers, a thinner pipeline of new listings and a continued pull toward deeper and higher‑valued overseas markets, the UK index remains heavily concentrated in older‑economy sectors.
Does this market and economy disconnect matter?
Not so much for investors, but yes for government.
Over the short term, the global revenue base of FTSE 100 companies means the market is driven far more by international conditions than by domestic ones. This can be an advantage: overseas earnings help cushion UK equities during periods of weaker UK data, and the market’s different sector mix offers diversification at a time when, for example, US equity valuations look stretched.
Over the longer term though, the implications could be more concerning. The market’s tilt toward financials, energy and mining also makes it more exposed to global cycles than to the structural growth themes seen elsewhere. And if high‑growth UK companies continue to list overseas or stay private, UK public market investors risk missing out on the sectors shaping future growth; the danger is the value they generate accrues elsewhere. Indeed, the UK economy, suffering a long-standing productivity puzzle, is failing to keep pace with global peers.
The current government certainly sees encouraging UK investment as key to improving the country’s growth prospects. Examples include the UK listing relief referenced above and increased innovation funding, which are intended to support development of both public and private UK markets. But any evidence of success in improving UK growth and value creation will be slow to emerge and challenging to identify.
Implications for investors
Our overall view on UK equities remains positive. Valuations continue to compare favourably with global peers, particularly when viewed against the recent surge in US equity prices driven by strong technology earnings. After years of acting as a headwind, parts of the UK’s value‑tilted sector mix may act as a tailwind as investor sentiment rotates towards more reasonably priced areas of the market.
For investors with significant exposure to US equities, particularly where portfolios have become heavily tilted towards large‑cap tech, the UK can offer attractive diversification. After a period in which US exceptionalism became the default answer to almost every equity-allocation question, that is no bad place to start.
Additionally, investors with the appropriate liquidity profile can also consider private markets as a way to gain exposure to sectors under‑represented in UK public markets, including technology services and other structural growth areas.
Conclusion
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Despite lacklustre domestic conditions, the UK equity market still delivered strong absolute returns, outperforming Europe.
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Divergence between the UK economy and UK stock market reflects that the majority of large cap revenues are generated overseas as well as current positive investor sentiment towards “old economy” sectors.
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Various factors have contributed to the limited evolution of the UK market – including low levels of companies listing in the UK, and more attractive opportunities overseas.
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Disconnect between the UK economy and UK equities isn’t inherently negative: the market’s global revenue base and sector mix can be a source of resilience and diversification – particularly versus the concentrated, tech‑heavy US market.
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UK equities do not need the UK economy to be booming in order to perform well. But if the UK can combine better domestic growth with a stronger pipeline of listed companies, that would be even better.
Overall, our view on UK equities remains positive. Valuations continue to compare favourably with global peers and we believe the market offers attractive diversification from the US market.
Your questions answered
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The UK stock market is driven largely by multinational companies that earn most of their revenues overseas. As a result, global economic trends often have a greater influence on UK equity performance than domestic growth.
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While the UK economy is predominantly service-based, the stock market remains concentrated in sectors such as financials, energy and mining. This difference means stock market returns do not always mirror broader economic performance.
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UK equities offer exposure to sectors that are underrepresented in many global portfolios and currently trade at relatively attractive valuations. For investors heavily exposed to US technology stocks, they can provide valuable diversification and balance.