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

  • In the first quarter of 2019 GDP grew at a surprisingly robust annual rate of 1.8% y/y. Alas, this renewed strength is somewhat illusory as households, firms and even the government appear to be stockpiling ahead of Brexit. There are currently 124 cans of M&S Thai Chicken Curry Soup in the pantry at Pemberton Towers (other leading department store soups are also available). I suspect the Q2 GDP numbers will be disappointing when published and indeed, the Bank of England recently downgraded its forecast to the quarter expecting growth to be flat. 
  • Inflation remains muted with the CPI running at an annualised rate of 2.0% and  unemployment at its lowest level since 1974, the era of Slade, flares, strikes and Dirty Leeds. With weekly average earnings growing at 3.1% then at least households should be feeling a bit perkier, Brexit fears or not. 
  • The binary nature of Brexit makes forecasting UK monetary policy a lottery. Nothing is likely to happen until October following which a disruptive no-deal could even lead to a rate cut to head off a possible recession even though the anticipated sharp fall in the pound would be inflationary.  A deal of some sort could lead to a couple of rate rises next year taking rates up to 1.25% though the global trend is for loosening, not tightening as the global economy loses momentum.
  • UK public finances are actually in pretty good order so a combination of looser fiscal policy and an accommodative Bank of England should minimise, to an extent, the economic disruption of a no-deal exit. Most of the FTSE100 companies have future-proofed themselves anyway and are more worried about a Marxist Corbyn Government. The corporate damage from Brexit will be felt most keenly in the domestic smaller and mid-cap  companies, many of whose share price have already taken this on board. 
  • The stock market continued to rally in the last quarter with the FTSE now returning 12% ytd.as at June 30th. We discussed in some detail the sorry saga of Neil Woodford earlier in the newsletter and his demise has led to a series of stock specific disasters as he has been forced to unload bucketloads of stock and the short selling hedge funds have joined the party
  • In terms of valuation, the rally since January means the market is trading on a forward P/E of 12.5x, which looks like fair value given that earnings expectations are only in low single digit. There is though support from an enticing dividend yield of 4.5%, especially now that Gilt yields have plummeted so low.

Summary: Equities produced strong returns again this quarter in line with global markets but remain a hostage to Brexit with the spectre of a Corbyn Government in the background. The market valuation is no longer so attractive but is supported by a high dividend yield.

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