Investment Strategy:  First Quarter – Specific Market Reviews: United Kingdom

  • Poor old blighty, it missed out on the global upswing last year but will still suffer in any global slowdown and has the largest ever elephant in the room to contend with, growth and monetary policy for years ahead being dependent on Brexit. An orderly withdrawal would lead to upgraded growth forecasts, prompting at least one interest rate rise this year. A disorderly ‘no-deal’ exit threatens a recession with all manner of gruesome ‘growth will fall by’ forecasts.
  • The economic picture is currently lacklustre with growth forecast to be in the region of 1.5% for the next few years even assuming an orderly exit from the EU. The well documented carnage on the High Street in the run up to Christmas, spreading online as shown by the profit downgrade from ASOS, paints a very depressing picture.
  • A chink of blue sky amidst the dark clouds. UK average earnings are rising at an annual rate 3.3%, the fastest rate since the 2008 financial crisis, and are likely to remain firm with unemployment at 4%, the lowest rate since 1975. This is well above the CPI rate of inflation, currently 2.3% and falling as the oil price collapse is reflected in the numbers, meaning that real income growth for households is finally increasing after years of stagnation.
  • UK equities remain a pariah, shunned and unloved, especially by overseas investors spooked by Brexit. I frequently listen to Bloomberg TV to catch the Wall Street close and it is full of US talking heads claiming that the UK is ‘un-investable’ as the centuries long tradition of political stability and reputation as the best country in the world for ‘doing business’ are shattered by Brexit. The FTSE index has continued its valuation de-rating as share prices fall and now trades on a price/earnings ratio of 11.5x and a dividend yield of around 4.5%, already pricing in a materially worse outlook for profits as we go into 2019.
  • Not only is the weakness of sterling burnishing corporate earnings it is also tempting foreign predators into UK boardrooms. The Takeda bid for Shire, Comcast for Sky and Coca-Cola for Costa Coffee (hopefully they’ll still sell chocolate tiffin) being high profile examples. If sterling remains below UD$1.30 we would expect more foreign led M&A this year.
  • The FTSE 100 index fell by 9% last year, all in the last quarter. The index actually fell far more in ‘price terms’ from 7687 to 6728 but the ‘total return’ was enhanced by the substantial dividend yield. Small and mid-caps did even worse with the FTSE 250 falling by 13%. Growth stocks on high multiples have sold off sharply whilst domestic stocks like retailers, homebuilders and banks have been absolutely clobbered by Brexit. Healthcare, consumer staples and even telecoms and utilities have fared better given their defensive ‘safe haven’ attributes and in some cases having their overseas earnings enhanced by the weaker sterling. All in all though, a blood bath.

Summary: The stock market has fallen heavily, is volatile in the extreme and is being shunned by overseas investors spooked by the horrors of the Brexit process and the fear of a Corbyn government. The market though is oversold and trading on a cheap valuation with a high dividend yield. Politics will continue to dominate until some resolution is achieved but a lot of bad news is already priced into the market.

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