The investment case for UK equities may be stronger than it has been for years, argues Eustace Santa, co-manager of the IFSL Marlborough Special Situations, UK Micro-Cap Growth and Nano-Cap Growth Funds.
In 1998, when the dot-com bubble was nearing its peak, Robert Farrell, formerly Merrill Lynch’s Chief Market Analyst, published a list entitled ‘Market Rules to Remember’. It received little attention.
The list was published again a few years later. Having been scarred by the bubble’s spectacular bursting, the investment community suddenly realised Farrell’s rules made a lot of sense.
They seem relevant again today, amid growing fears that the events of the late 1990s and early 2000s could be repeated. Various individuals and organisations are warning that, much like during the dot-com frenzy, some stock valuations are getting out of hand[1].
It was “irrational exuberance” over telecom infrastructure which toppled the dominoes a quarter of a century or so ago. This time it is a voracious appetite for artificial intelligence (AI) infrastructure which is setting alarm bells ringing.
This kind of uncertainty can encourage investors to re-examine their choices. In this instance, in my view, any such reassessment underlines the case for UK equities as a whole and for UK smaller companies in particular – and three of Farrell’s celebrated tenets can help us understand why.
- Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
The first point to address is how we got here. Farell provides an eminently succinct explanation: the market has become too narrow.
The US has exerted a near-gravitational pull in recent years, with a handful of tech titans – the so-called “Magnificent Seven” – attracting the bulk of inflows. To date, allowing for occasional blips, such an approach has proved capable of delivering handsome returns. Yet forever relying on a tiny array of stocks centred on a single sector, industry or region is seldom shrewd.
With huge exposures to multi-trillion-dollar businesses, passively managed index funds now find themselves notably vulnerable to a shift in sentiment. The argument for diversification is compelling – so why are some investors so reluctant to turn their gaze towards the UK?
- Fear and greed are stronger than long-term resolve
There are numerous reasons why UK equities – smaller companies perhaps foremost among them – have remained comparatively unloved of late. Negative dynamics have included the vote for Brexit, the impacts of the COVID-19 pandemic and continued economic and political instability.
Yet it makes no sense to infer that every single company in the country has been stripped of all appeal. While the bigger picture obviously has a degree of influence, a business’s unique attributes often offer the most reliable indication of growth potential.
Crucially, both in the UK and elsewhere, smaller companies have a record of outperforming their larger counterparts over time. Unfortunately, as Farrell recognised, investors are frequently governed by their emotions – and emotions usually foster a short-term outlook.
- The public buys the most at the top and the least at the bottom
Relatedly, investors tend to be at their most bullish when markets are riding high and at their most bearish when markets are plunging. This is the stuff of human nature, as Farrell acknowledged, and it explains why US AI stocks have continued to enjoy copious inflows and why UK equities, relatively speaking, have been shunned.
But the reality is somewhat less clear-cut. Downturns and/or low valuations can give rise to significant opportunities, not least over the long term.
As Warren Buffett once famously outlined in a letter to Berkshire Hathaway shareholders, it is rather like asking whether we would prefer hamburgers to be cheap or expensive. If we prefer the former, logically, we should also prefer lower-priced stocks.
Time to think differently
So what does all this mean? Bearing the above rules in mind, we might summarise the current situation as follows.
Many AI company valuations may have become unduly stretched. Meanwhile, having been out of favour for so long, many UK stocks are still undervalued – even though Britain is home to leading businesses in spheres such as aerospace and defence, chemicals, construction, engineering, healthcare, life sciences and medicine.
Investors who care to explore the lower end of the market-capitalisation spectrum should find many UK smaller companies that are especially innovative, agile and capable of long-term growth. In my opinion, these are ready to outperform their US peers in the years ahead.
I must stress that none of this is intended to spark panic. There may not be trouble ahead in the AI arena. History might neither repeat nor even rhyme. To quote another of Farrell’s rules: “When all the experts and forecasts agree, something else is going to happen.”
Even so, it is seldom wise for investors to put all their eggs in one basket. Irrespective of whether they end up getting cracked, now could be a good time to think differently and look further afield.
[1] See, for example, CNBC: “‘Buckle up’: IMF and Bank of England join growing chorus warning of an AI bubble”, October 9 2025 – https://www.cnbc.com/2025/10/09/imf-and-bank-of-england-join-growing-chorus-warning-of-an-ai-bubble.html.
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