The strong rally in the FTSE 100 has been one of the defining market stories of 2025 and early 2026.
After decades of sluggish progress, the index has not only crossed major milestones but is now pushing toward new highs with surprising momentum.
This sharp upward trend has rewarded investors who stayed patient with large-cap UK stocks. However, it also raises an important question, is the next opportunity no longer at the top, but further down the market in smaller companies?
While the FTSE 100 continues to benefit from momentum and global exposure, the FTSE 250 tells a very different story.
Mid-cap and smaller UK stocks have lagged behind significantly, still struggling to reclaim their previous highs from 2021. This divergence has created a valuation gap that some analysts believe is too large to ignore.
One of the main reasons behind this underperformance is structural. UK pension funds have dramatically reduced their exposure to domestic equities over the past decade, pulling billions out of the market.
At the same time, the rise of passive investing has funneled most capital into large-cap stocks, leaving smaller firms overlooked.
As a result, many fundamentally strong smaller companies are trading at discounted valuations compared to their larger counterparts.
This situation has been further amplified by investor psychology. Markets tend to chase performance. As large-cap stocks rise, more money flows into them, while underperforming smaller stocks are often ignored.
Over time, this creates a cycle where big companies keep getting bigger, and smaller ones remain undervalued.
However, this imbalance may also present an opportunity. Analysts at Panmure Liberum argue that UK small and mid-cap stocks are currently trading at their deepest discount relative to large caps since the dotcom era. This suggests that, from a historical perspective, these stocks may be significantly undervalued.
There are also early signs of improvement. Many smaller companies have started buying back their own shares, signaling confidence in their valuations and future prospects.
On the macroeconomic side, conditions appear to be stabilizing. Inflation is easing, interest rates are expected to decline, and economic growth may gradually improve.
These factors typically support equity markets, particularly domestically focused companies that are more sensitive to local economic conditions.
Another potential catalyst lies in capital flows. If UK policymakers succeed in encouraging domestic investment back into local equities, smaller companies could benefit the most.
Unlike large multinational firms in the FTSE 100, many mid and small-cap businesses are closely tied to the UK economy, making them direct beneficiaries of renewed local investment.
That said, investors should remain cautious. Political uncertainty in the UK has not disappeared, and smaller companies are generally more volatile and economically sensitive than large caps. Timing also matters, momentum still favors the FTSE 100, and trends like this can persist longer than expected.
In conclusion, while the FTSE 100’s surge may not be over, the more compelling long-term value could lie in the overlooked segments of the market.
For investors willing to tolerate higher risk and take a contrarian approach, UK small and mid-cap stocks may offer significant upside potential. The key question is not whether the opportunity exists, but whether investors are ready to shift their focus before the broader market catches on.
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