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The “era of austerity is over,” the Chancellor proudly declared in his Autumn Budget on 29th October 2018. In the increasingly labyrinthine world of British politics, a lot has changed since this bold pronouncement: the Government has been defeated on critical legislative votes by margins of historically significant proportions; the Prime Minister has survived a vote of confidence in her leadership; 16 ministers have resigned; and MPs from both Labour and the Tories have formed the breakaway “Independent Group.”
Needless to say, this has all occurred against a backdrop of profound uncertainty over the ultimate outcome of the negotiations over the UK’s departure from the European Union.
Given these extraordinary machinations, UK equity investors might reasonably have expected a bumpy ride, and to a certain extent, as has been the case for equity investors the world over, this is exactly what has transpired. Happily though, it has not all been in vain; on the day of the Autumn Budget, the FTSE 100 index traded at 7,026 points.
Around the time of writing, on 5th March 2019 (coincidentally, the 10-year anniversary of the start of quantitative easing by the Bank of England), the index is at 7,183. From a cursory glance, investors could be forgiven for coming to the conclusion that the UK equity market has simply taken the events of these past four months firmly in its stride.
In reality though, looking purely at the index level masks a more complicated picture, and one that UK equity investors would do well to better understand. What, if anything, has changed in the time between the last Budget and the upcoming Spring Statement?
First, the good news. The unfolding political dramas notwithstanding, from a fundamental perspective, the UK economy is in remarkably good shape. Indicative suggestions that the annual budget deficit for the year will be in the region of £20 billion should be heartening; it sounds like a large number, but as a proportion of the UK’s gross domestic product (GDP), it is barely of the scale of a rounding error.
Meanwhile, higher-than-forecast tax receipts will provide a welcome fillip to the Treasury, and indeed the Government, at a time when good news has been in relatively short supply; expect more of the austerity-is-over mantra from the Chancellor when he stands up in the Commons on 13th March.
The labour market is another area that appears to have shaken off concerns about the UK’s departure from the EU. There are now around 900,000 job vacancies in the UK, and private sector wage growth is running at 3% per annum. Against this backdrop, the Chancellor may feel he can further ease restraint on public sector pay. Given quiescent inflation, real incomes in the UK are rising, and this is of course welcome news.
In my view though, investors would be well advised to be a little circumspect about the apparent nonchalance of employers when it comes to the potential economic drag of a “no-deal” Brexit. In reality, Brexit uncertainty has begun to impact on economic growth – itself a key driver of low unemployment levels.
Quarterly GDP growth of 0.2% in the fourth quarter of 2018 is hardly comforting, and is well below the 0.5%-0.6% growth of which the UK economy should be capable. Given these figures, there is little point in pretending that both business and consumer confidence are starting to show signs of strain under the pressure of the Brexit “handbrake.”
All is not lost though; if an EU withdrawal agreement can be secured, I believe there is every reason to believe that GDP growth and consumer and business confidence should come bouncing back. Indeed, by the second half of 2019, and into 2020, UK economic growth could be accelerating nicely. By contrast, few would suggest that the medium-term outlook for continental Europe is so rosy, with Germany now considered by some economists to be teetering on the brink of recession.
That said, exogenous factors are starting to align more favourably for Europe, too. Germany – which exports manufactured goods from cars to machinery in staggering volumes – is particularly sensitive to the changing economic fortunes of China. Inevitably, weaker Chinese growth and the trade tensions between China and the US have weighed on Europe’s economy. But Chinese economic stimulus measures and reforms, a US election-inspired resolution of the trade tensions (and contingent soft landing for the US economy), and the US Federal Reserve’s renewed dovishness should all bode well for the European and UK economies.
Turning our attentions back to UK plc, sterling has continued to act as “judge and jury,” and the recent verdict has been a pretty favourable one, with the pound rallying noticeably against the dollar and the euro in the early months of 2019. This may, of course, lead to the downgrading of certain large multinational exporters, especially the big oil and mining companies that sell most of their wares priced in US dollars. However, if the Brexit “handbrake” can be released through a successfully negotiated deal, then I believe the currency effect will take more of a back seat in investors’ considerations and that corporate fundamentals will return to the fore.
UK equity investors should be drawing further comfort from growing indications that we may have reached “peak Corbyn,” long a source of concern to the many international investors who have redeemed their holdings in listed UK companies.
This all begs the question of when UK equity investors should return to the market. I believe the case for revisiting UK stocks is compelling. Valuations remain fairly undemanding, with the FTSE 100 index trading on around 12.7 times 2019 forecast earnings, and the dividend yield, at 4.8%, is similarly enticing.
While I do not expect profits growth for the year as a whole to be dazzling – something in the region of 5% seems realistic to me – the potential for an attractive total return from large-cap UK companies means, in my view, that that they merit closer examination, as the strong year-to-date returns from domestic businesses such as Lloyds Banking Group (up 21% this year to date) and Next (up 30% over the same period) bear witness.
With an increasingly resilient sterling providing a benevolent tailwind for businesses like these, all we now need is a deal. Let’s hope that common sense can prevail in the House of Commons.
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 Bloomberg, 07/03/19
 Bloomberg, 07/03/19
 ONS via FT, 21/02/19
 ONS, 19/02/19
 ONS, 11/02/19
 Bloomberg, 05/03/19
 Bloomberg, 05/03/19