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

  • As we finally reached the Brexit denouement (or at least thought we had!) the economy has taken a turn for the worse. The UK economy expanded at only 1.4% in 2018, its slowest annual rate since 2009 with particularly meagre growth of 0.2% in the last three months of the year. The Office for Budget Responsibility (OBR) is now forecasting that the UK economy will grow at only 1.2% this year, the slowest pace since the financial crisis. That is a significant cut from the 1.6% expansion predicted by the government’s economic watchdog last October. Economic forecasts are invariably wrong, and in this of all years this will no doubt prove to be the case once again. It does though indicate the direction of travel.
  • The uncertainty that has plagued the economy for the last two years is likely to persist, capital spending growth was negative last year and significantly weaker than the UKs competitors. House prices are stalling, good news for youngsters trying to get on the housing ladder (personal interest comment!) but this has always been a powerful barometer of overall economic well-being. According to Rightmove, asking prices were down 0.8% on average in the year to March including a tumble of 5.5% in London. Households will keep their hands in their pockets and businesses will not commit to medium term capital plans until they know with much greater certainty the Brexit outcome. This lack of investment and the weakening housing market do not bode well for the next few years. The OBRs forecast for the next few years is only around the 1.5% level, but given Brexit (or not) who on earth knows.
  • Growth is slower for reasons other than Brexit; the global economy is slowing in part due to the US/China trade tensions which have hurt trade heavy economies with Italy and Germany struggling badly. Nevertheless, three years after the vote Brexit is now certainly spooking companies and having a marked impact on their investment
  • More positively, the annual rate of consumer price inflation has fallen to a two year low of 1.9% whereas wages are growing at an annual rate of 3.4% at a time of very low unemployment, so households should be enjoying a significant boost in their disposable spending power.
  • Bank of England policy remains Brexit dependant and it cannot raise rates until an outcome is reached, and some sense of how that outcome will affect the economy is achieved. This likely precludes any interest rate rises this year.
  • As sterling has rallied versus the dollar this quarter the transactional impact has led to a decline of around 3% in UK earnings expectations, with the consensus now forecasting growth of only around 4% in 2019 and 8% in 2020.
  • In terms of valuation, the rally since January means the market is trading on a forward P/E of 12x, which feels fairly supportive and with an enticing dividend yield of 4.7%. A broad market P/E may hide a multitude of sins with a number of the companies having unsustainably high yields so beware value traps, especially in heavily leveraged companies. Nevertheless, the UK certainly looks the cheapest of the major developed markets.

Summary: Stock market returns were strong in line with all global markets but remain a hostage to Brexit with the spectre of a Corbyn Government in the background. The market has been shunned by foreign investors and still trades on a relatively cheap valuation with a high dividend yield.

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