For the first half of my career, UK equity valuations closely tracked the yields on the type of gilts where returns are linked to inflation. The 2000–03 bear market broke that neat relationship, but it is making a comeback. As a green young strategist in the early 1990s, I asked my boss how to value the UK stock market. His gruff reply: “It’s simple, equities trade on the same yield as linkers.” That rule of thumb worked for many years. If real yields rose, as in 1994, then equities derated. If real yields fell, as in the late 1990s, they re-rated.

There is a simple logic behind this. Both assets offer an inflation hedge, albeit of different quality. Index-linked gilts adjust principal and coupons in line with the Retail Prices Index. Equities pay dividends that should, theoretically, rise in line with nominal corporate revenues. However, during the early 2000s bear market, the relationship broke. Index-linked prices rose relentlessly, driving the benchmark real yield below zero in 2012 and down to almost minus 3 per cent in 2021. Meanwhile, equity dividend yields drifted higher, including spikes as shares fell during the 2007–09 financial crisis and 2020 Covid pandemic panic. Having matched index-linked yields for the 1980s and 1990s, equities paid a yield premium of 3.3 percentage points on average between 2001 and 2021.

To explain this profound change, I could use technical terms such as equity risk premia, terminal growth, natural rates and the like. But let’s keep it simple. It was about buying and selling. The 2000—03 bear market in stocks left deep scars, especially among UK pension funds. Falling equity prices depleted assets while lower bond yields increased future liabilities. Defined benefit pension funds fell into deficit and many closed to new entrants. New accounting rules encouraged fund trustees to match assets against liabilities more closely. Many adopted liability-driven investment (LDI) strategies. The impact of this on asset allocation was stark. UK pension funds held roughly half their assets in UK equities in 1999. That weighting fell below 1 per cent in 2025 for defined benefit schemes, according to the Pension Protection Fund. As they sold UK equities, these funds bought into liability-matching index-linked gilts, pushing the weighting up to 31 per cent in 2025.

This was like pouring a gallon into a pint pot. The UK equity market (currently worth some £4.9tn) is much bigger than the linker market (currently about £688bn). And the big move in linker prices was not just happening for domestic reasons. The bond-buying programmes by central banks known as quantitative easing contributed to negative real yields everywhere. This relative valuation shift encouraged the “de-equitisation” of the UK stock market. Listed companies issued debt to buy back shares. Others delisted via debt-financed mergers and acquisitions. But things started to reverse in 2022. Central banks hiked interest rates and began to unwind QE, driving real yields up everywhere. In the UK, the September 2022 mini-Budget spooked the markets and savaged leveraged LDI strategies. Index-linked prices collapsed, pushing real yields back into positive territory for the first time in 10 years. They are still rising amid fiscal concerns and fears of rate hikes. The 15-year real gilt yield is now 2.3 per cent, not far below the FTSE dividend yield of 3.0 per cent. What does this all mean? First, it reduces the financial logic behind de-equitisation. The giant spread between equities and linkers has narrowed, making UK stocks more attractive relative to bonds. Second, it reverses the flow of capital from equities to linkers. Pension funds may start to rebalance back into UK equities, supporting valuations. Third, it challenges the narrative that UK equities are permanently out of favour. The market may be poised for a re-rating as real yields stabilise and investors reassess the risk premium. The era of negative real yields is over, and with it, t...