UBS strategists say the UK equity market is showing the first signs of a recovery, but they counsel investors to take a selective approach rather than embrace broad index exposure. In a European Equity Strategy note dated Friday, UBS argued that the market now rewards targeted stock selection - particularly companies with strong cash-return policies and underowned small- and mid-cap issuers - rather than passive bets on the entire market.
According to UBS, both the FTSE 100 and FTSE 250 - when weighted by sector PMI New Orders - have pivoted back toward recovery after a recent slowdown. The turn has been led by improvements in banks and consumer goods, the strategists said, and has coincided with the FTSE 100's outperformance of European peers since February 2025 and a general upward trend in the FTSE 250.
On a rebased 12-month basis, large-cap UK equities have led peers including the Stoxx Europe 600, the Russell UK Mid 150 and the FTSE 250 ex-investment trusts, UBS noted. Yet the firm described the current market setup as "a measured re-warm, not a chase," stressing that style diagnostics continue to favor active stock selection rather than index beta.
Ownership profile and structural discount
UBS highlights that the UK market's persistent discount to European equities reflects structural, not merely cyclical, factors. Domestic investors now hold approximately 20% of UK equities, while U.S. investors control 44.1% and Luxembourg-domiciled funds account for 12.1%, Bloomberg data cited in the note show.
The report points to a long-term shift in institutional allocations: UK defined benefit pension schemes trimmed their UK equity holdings from about one-third of assets in the mid-2000s to under 2% by 2023. With domestic institutional demand diminished, buybacks have become the primary source of local demand. FTSE 350 companies executed 187 buyback programs in 2025, up from 54 in 2018, per Bloomberg data referenced by UBS.
In parallel, the UK's weight in the MSCI ACWI has declined by roughly 6 percentage points over the past 16 years, compressing passive inflows and making the market more reliant on active re-allocation decisions, UBS said, citing Bloomberg and MSCI figures.
Valuation and earnings picture
On valuation metrics, UBS says the FTSE 100 is largely in line with the S&P 500 and the MSCI ACWI on a price-to-earnings-growth basis, suggesting large caps are not anomalously cheap but are priced consistently with their expected trajectory. By contrast, FTSE 250 companies trade at materially lower PEG ratios than global peers and remain deeply discounted on forward price-to-book relative to MSCI Europe, according to Datastream data cited in the report.
UBS also points out that the 12-month forward relative P/E distribution for FTSE 100 constituents is now concentrated in the 75%-125% band, which argues against a broad-based re-rating of the index. At the same time, earnings revisions for fiscal years 2026 and 2027 remain net negative overall, although FY26 estimates have seen a marginal upward revision year-to-date, driven principally by upgrades in the materials sector.
Sector-level drivers for FY26 EPS growth are led by mining, banks and pharmaceuticals, while the energy sector is lagging. Expectations for FY27 have softened across most sectors, according to Datastream data cited by UBS.
Macro outlook and policy expectations
UBS economists forecast UK GDP growth of 1.1% in 2026 and 1.4% in 2027, following estimated growth of 1.3% in 2025. Consumer price inflation eased to 3% year-on-year in January 2026 and is forecast to average 2% in 2026, with a marked step-down expected in April when household energy bills are cut.
Monetary policy expectations in the UBS note include two 25-basis-point cuts from the Bank of England in March and June 2026, taking the terminal rate to 3.25%. UBS cautions, however, that risks are skewed toward further cuts below that outcome, citing BoE data.
Flows, options and short-term positioning
UBS observes that options markets have moved from a period of "conditional calm" to early hedging activity, while domestic outflows persist across both active and passive UK equity fund categories. In the four weeks to Feb. 18, LSEG Lipper data referenced by UBS show that alternative long/short equity funds were the only UK equity fund type to register positive active inflows.
Practical screening frameworks for investors
To operationalize their selective stance, UBS outlined two screening frameworks intended to help identify potential opportunities:
- Quality yield and cash discipline screen - This targets FTSE 350 companies with forward dividend yields above 3.5%, positive buyback yields and forward free cash flow yields above 5%.
- SMID alpha dislocation screen - This focuses on sub-$10 billion market cap companies with forward EV/EBITDA below 9x, forward free cash flow yields above 5% and crowding scores below 10.
UBS positions these screens as a way to capture cash-return leadership and areas where active managers can exploit underownership and valuation dislocations rather than relying on a blanket allocation to UK indices.
Conclusion
In sum, UBS sees a cautious recovery taking hold in UK equities but frames the market as an optional allocation that requires active selection. The combination of structural ownership shifts, concentrated valuation distributions among large caps, mixed earnings revisions and continued domestic outflows underpins the bank's preference for targeted exposure to buyback- and dividend-focused large caps and selectively chosen SMID names that meet its dislocation criteria.