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

  • The UK economy grew by 0.4% in the second quarter after the decidedly lacklustre Q1, driven by stronger growth in both services and construction sectors as the sun shone brightly down (remember that?). This represents an annualised growth rate of 1.3%, hardly compelling given the stronger growth elsewhere, most notably in the US. Brexit continues to weigh heavily on business confidence and remains a major deterrent to companies long term investment plans.
  • The unemployment rate of 4% is at its lowest level since 1975 and this is finally starting to feed through to wage growth which grew at an annualised rate of 2.9% in the three months to end July. The inflation rate is 2.7%, down on the peak of 3.1% in 2017 but like wages showing a pick up over the summer. This level, which jumped in August, is around the tipping point at which markets feel they need to worry about inflation or not.
  • The stock market has become increasingly pre-occupied with Brexit which I discuss in detail (groan) in the end-piece of the newsletter. Our best guess remains a cobbled together last minute Withdrawal Agreement which keeps us in the single market and customs union before more negotiation during a 21 month transition period but the risk remains of a ‘no deal’ leaving the UK politically and economically isolated. Politics is certainly playing an increasing role in unnerving the market with the two ugly sisters, Brexit and Corbyn, filling investors with dread. Seldom if ever have politicians been held in lower esteem with the Tories a bunch of second-raters tearing themselves apart over Brexit and an increasingly brutish Labour Party doing the same over anti-Semitism, disgraceful for a party which in the past has championed tolerance and inclusion. The policies coming out of the Labour Conference are hardly going to make UK investors sleep easier at night with 10% of listed company’s shareholdings being handed over to employee benefit trusts, stacking company boards with workers and a wide scale programme of nationalisation. Self-interest rather than the national interest is now the norm across all parties and we voters are losing faith in the ability of politicians of any stripe to deliver sensible policies and competent government.
  • The Bank of England raised interest rates by 0.25% at their August meeting to 0.75%. Governor Carney was at pains to stress that any further hikes will be gradual, and dependant on the outcome of Brexit. The use of the word ‘gradual’ in the UK appears to differ to its use in the US. According to the US Federal Reserve gradual appears to signify a 0.25% rate hike every quarter, to the Bank of England it means one 0.25% hike a year. Carney is effectively giving himself a bit of Brexit insurance, allowing scope for a rate cut if a hard Brexit leads to the economy hitting the buffers or else raising rates slightly faster if a soft Brexit leading to economic optimism and expansion. Carney has extended his UK vacation to the end of the Brexit transition period in 2020, two cheers for his economic management thus far, raspberries for his lamentable ‘forward guidance’.
  • The UK remains unloved; outflows since the Brexit vote continue whilst the FTSE100 index has underperformed the MSCI World Index ex UK by around 25% in local currency over the last five years (50% in sterling terms!). This is partly due to Brexit and partly because of the defensive composition of the FTSE index. Could this be the time to be contrarian? M&A activity shows that overseas corporates, if not investors, see plenty of value in the UK stock market with Sky, Shire and Randgold being three large and high profile companies about to disappear into foreign hands. After last year’s bumper corporate earnings, expectations are lower at around 10% for this year and 8% in 2019. The forward P/E of 12.5x these earnings expectations looks pretty supportive, especially alongside a dividend yield of nearly 4%.

Summary: Brexit looms ever closer and is having an increasing effect on the stock market, as is the associated possibility of a Corbyn Government. Valuation is not overtly expensive alongside a noticeably high dividend yield, the earnings outlook is good and M&A activity is strong. Politics though will remain the driving force.

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