Investor sentiment towards the US equity market has shifted from euphoria to anxiety, as the reality dawns that tariffs could lift inflation, driving a US economic slowdown. At the same time, cracks are emerging in the “Magnificent 7” tech stocks, as doubts emerge over the sustainability of their dominance, with new Chinese AI rivals highlighting how rapidly technology is evolving. US equities had become seen as invincible, driving valuations to eye-watering levels. Even if the US economy emerges intact, this wobble has made investors aware of the need to question the widely held view that the US can be relied upon to deliver consistent capital growth into perpetuity. This shines a light on the need for diversification. In the past, diversification meant selling UK equities to buy overseas equities, but with investor allocations to UK equities having slumped in the past decade, the tables have now turned. As the reliability of US growth stocks fades, investors could turn their attention to UK high yield stocks. Instead of relying on capital growth which may or may not happen in US equities, investors could have far greater visibility of returns if they look for stocks that offer dividend yields in excess of 6% plus buybacks on top.

UK equities are cheap

It is when stock markets like the UK are most unloved that the greatest valuation bargains can be found. It is hard to deny that UK equities are cheap, particularly many small and mid cap stocks, but up to now the catalysts for a revival have been lacking. Investors have shunned UK value stocks, preferring the excitement of US growth stocks. Investors have got used to the US market delivering reliable, outsized returns. They have applied the saying “if it ain’t broke, then don’t fix it” to their asset allocation. So it is with some disbelief that investors have watched the US equity market starting to under-perform the UK equity market so far in 2025.

A hunting ground for value and income stocks

Is this a freak event or could it mark the start of a major rotation? To answer this question, we need to run through the underlying drivers of this shift. First, President Trump’s plain-speaking on tariffs and defence spending have given a jolt to the UK and Europe, resulting in a surprisingly decisive policy response. While Trump’s policies at first glance appear unwelcome, they might in time turn out to help us to resolve structural issues and drive-up economic growth. The multiplier effect of increased defence and infrastructure spending is set to provide a new source of economic stimulus. This is most evident in Germany, but it is also visible in the UK where defence spending is being prioritised over welfare spending, fitting nicely into the Government’s agenda to make economic growth the number one priority. Higher defence and infrastructure spending could help many higher yield Industrial and Construction stocks. The UK’s de-regulation push is adding fuel to the impetus for economic growth, helping stocks in sectors such as Financials and Housebuilders. The difficult global backdrop is helping to focus minds on devising policies that can propagate growth without costing the taxpayer a penny. At the same time, geopolitical tensions are likely to result in inflation remaining elevated, meaning that interest rates are likely to remain higher-for-longer, supporting Financials stocks. Policy volatility from the Trump administration will remain a constant, creating bouts of uncertainty, but overall, we see a decent hunting ground for UK high yield stocks.

Share prices have the potential to react strongly as investors simply aren’t positioned for this scenario. There is little doubt that a large valuation gap exists between US equities and UK equities. Yet until recently it has been difficult to envisage which conditions would create the investor buying necessary to cause this gap to narrow. So with this question in mind, Bank of America’s March 2025 Fund Manager Survey made particularly interesting reading. This survey highlighted the biggest reduction in allocations to US equities on record, while UK equities and Eurozone equities were the two asset classes seeing the biggest increase in allocations. The survey showed a record shift to high dividend yield stocks, away from low dividend yield stocks. Technology was the sector seeing the greatest reduction in allocations.

US impact on UK and European equities

The reality is that even a small shift away from US equities could have an enormous impact on UK and European equities, after so many years in the doldrums. The structural issues that investors worry about don’t need to disappear completely for these markets to rally, rather they just need to become less intense. The sharp rally in the FTSE 100 Index suggests that the initial shift in investor flows has been into large cap stocks, rather than small and mid-cap stocks. This is entirely normal when there is a rotation, but it leaves a glaring catch-up trade to come during the course of 2025, as investors broaden their allocations out into small and mid-cap stocks. The abrdn Equity Income Trust selects from UK stocks across the entire market. Being agnostic about index weightings, we are poised and ready to take advantage of valuation opportunities wherever they emerge. In an environment as fast-changing as the current one, we expect a lot of these opportunities to arise in the months ahead. As US equities fade, investors can look to the UK for dividend yield, dividend growth and valuation re-rating potential. These can be powerful ingredients for attractive investment returns. And unlike US equities, there is little or no expectation for growth, setting the bar very low indeed.

Important information

Risk factors you should consider prior to investing:

Other important information:

Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.

Find out more at www.aberdeeninvestments.com/aei or by registering for updates. You can also follow us on Facebook, LinkedIn , YouTube and X.