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Investments slow amid Brexit

In spite of the Brexit cloud hovering over the British Isles, the UK economy itself has proven surprisingly resilient.

Low unemployment, a pick-up in wage growth relative to inflation, and expansion in the dominant services sector would all normally be welcomed by investors. Should we view the UK as an attractive place to invest, despite its political woes?

At around 4 per cent, UK unemployment is brushing up against historical lows, and faring much better in this regard than its European counterparts, with the exception of Germany.

Indeed, the UK’s latest jobs market data demonstrated the lowest unemployment rate since the 1970s, at 3.8 per cent.

Meanwhile, on mainland Europe, unemployment in France, Italy and Spain is around 9 per cent, 10 per cent and 15 per cent respectively – although these countries do usually have structurally higher levels of unemployment than the UK.

Key points

  • UK unemployment is at historic lows
  • In the corporate sector, confidence has stagnated
  • Brexit and political turmoil has stalled capital spending plans

Typically, with lower unemployment comes upward pressure on wages, which we are witnessing in the UK today.

In the three-month period to the end of May 2019, total earnings (not including bonuses) rose by 3.6 per cent – the highest since mid-2008.

Low and stable inflation is allowing this wage growth to translate into rising disposable incomes and increased spending power for British consumers – further good news for the economy. 

Against this favourable labour market backdrop, UK interest rates have remained benignly low, and are likely to stay that way for the foreseeable future.

We believe that the Bank of England is ultimately looking to increase its store of dry powder in advance of any future recession – that is, raising interest rates so that it has room to cut them again in periods of economic weakness. For now, paralysed under a weight of Brexit uncertainty, it has little choice but to remain on the sidelines.

Over the longer term, we anticipate only gradual and minimal interest rate increases, particularly given the levels of debt in the economy.

In the corporate sector, confidence and investment have both stagnated – typically a bad sign for economic growth – and more recently this has been evidenced in weaker economic data. However, rather than invest, UK businesses are currently stockpiling high levels of cash.

These excess corporate savings, held tight by nervous businesses, could be released if a Brexit resolution materialises. In turn, this could offer a potentially significant investment boost to the UK economy.

Nonetheless, the outlook for the UK economy is troubled, not least by a lack of clarity on Brexit, as well as the entwined domestic political turmoil.

This week, Conservative party members chose their next party leader, and by extension the new prime minister.

Shortly after, the UK will be back to the negotiating table with the EU, which has previously made clear that it has no intention of reopening the withdrawal agreement. However, a change of leadership in the UK and at the top of key EU institutions may just provide fresh impetus to the discussions.

Given the deeply uncertain political backdrop, the ‘wait and see’ attitude currently being adopted by investors is entirely understandable, as is the mirroring of this unease in the corporate world.

It is worth noting that while businesses stockpiling their cash could well mean a boost to the economy in the future, in today’s terms this means that growth in corporate investment has stalled.

Prolonged uncertainty surrounding Brexit could delay capital spending plans further, without the guarantee that these funds will be released into the economy in the future. 

The UK’s dominant economic sector, services, is still in expansionary territory, which is encouraging.

However, in keeping with the global growth picture and concerns around global trade, the UK’s manufacturing sector, albeit much smaller than its services sector, is more troubled, with the latest business surveys showing that it is in contraction.

Further, there are key pockets of weakness in both the retail and real estate sectors, both of which faced an especially challenging 2018.

In addition, the UK has some notable structural problems. Perhaps most conspicuously, it has yet to deal effectively with its debt issues. The UK still sports twin deficits, meaning that the government spends more than it earns (fiscal deficit) and the country imports more than it exports (trade deficit), making it a net borrower overall.

In spite of its challenges, the UK has remained economically robust, and in the future could become an attractive place to invest once more.

The limited political will for a no-deal Brexit outcome is indeed a positive sign for domestically-focused UK assets and the potential for sterling strength ahead.

Nevertheless, UK shares remain markedly unloved by investors, and as a result they are also relatively cheap, appearing good value by virtually all measures, but particularly on price-to-book ratios (the total value of a company’s shares versus the value of its net assets).

Given its out-of-favour status, any change in sentiment could see large capital inflows to the UK stock market and provide a boost to valuations.

However, this simply cannot occur until we have more clarity in UK politics. Without this, and a more certain understanding of our future relationship with Europe, it is hard to justify significant further investment in the UK market in the near term.

By Nikki Howes

Source: FT Adviser

Marketing No Comments

UK stocks could surge when Brexit is settled

The bounce seen in global equity markets since the end of last week as a result of an improving political environment could be replicated in the UK if the Brexit process comes to a stable conclusion.

This is according to Russ Mould, UK investment director at AJ Bell.

His comments came as Asian and emerging market equities opened strongly this morning (December 3) following progress in the trade dispute between the US and China, with our sister title the Financial Times reporting that US president Donald Trump is to offer a “truce” in the dispute.

Mr Mould said the swiftness of the response by investors to the change in the political rhetoric indicated that if a similar change in the political weather were to happen in the UK, then the UK equity market would also increase sharply.

He said the UK market has underperformed all other developed equity markets in 2018, an outcome that has left it on a valuation multiple of just over 11 times earnings, which is considerably less than the long-term average for the market of 18.

The yield on the UK market of 4.8 per cent is also greater than that offered by other markets, and Mr Mould said this makes those markets “cheap.”

Aninda Mitra, senior analyst at BNY Mellon, said the market is “elated” by the developments in the trade dispute but he added that the reprieve could prove temporary.

Markets have also been boosted by comments from Jerome Powell, chairman of the US Federal Reserve, who stated last week that US interest rates may be approaching the peak level for now, and so not need to rise by as much as the market had previously expected.

Ed Smith, head of asset allocation research at Rathbones, said the move by Mr Powell has boosted markets, but that a change in relations between the US and China would provide an even bigger boost.

Jonathan Davis, Chartered financial planner of Jonathan Davis Wealth Management in Hertford, said there have always been issues in markets but investors should remember that this has not stopped equities rising consistently over the past century.

Source: FT Adviser