The UK’s problems are depressingly familiar: chaotic Brexit negotiations, weak government and a flagging economy. Sterling is near rock-bottom and the UK consumer appears to be losing momentum. However, more recently, manufacturing and investment data has proved a chink of light amid the gloom. Are things really as bad as they seem for the UK?
Many believe that the UK is facing real problems: Eric Moore, manager of the Miton Income fund, says the UK political situation is ‘at least as bad as we think’, adding: “The Government can’t get anything done. That means housing, education, energy policy is all in disarray. Also, we are one year on from Brexit and none the wiser.”
More important, to his mind, is the UK consumer. In spite of a bounce in last month’s retail spending figures, he sees the data trending lower. “The consumer is 60% of the UK economy. Households are feeling worse off, given higher inflation and the lower pound. Real wages aren’t growing much and this will percolate through the economy.”
The Outlook for UK Stocks
From an investment perspective, he believes that the shares of consumer-exposed companies such as retailers and pub companies have done badly, but with good reason. He believes areas such as the housebuilders, which have held up well to date, may be vulnerable from here.
Neil Veitch, manager of the SVM UK Opportunities fund, says that while the UK is certainly facing problems, the currency has functioned as an escape valve. Sterling is near record-lows against the Euro, and still weak against the US Dollar. This should encourage trade, and is already reflected in improving manufacturing figures. He says: “If we look six months ahead, net trade could be more positive to UK GDP.” He believes the figures on the UK consumer are not universally gloomy: “Recent staffing data showed a pick-up in July. Barclaycard spending data is up 3.5% year on year.”
He also believes there are more positive signs emerging from the Brexit negotiations: “The negotiating position is becoming clearer. They are talking about an exit bill. Chancellor Hammond is now talking about a transition period of two to three years and trying to reduce the uncertainty for business. There is a lot of residual uncertainty, but it is not right to say they have no idea what they are doing.”
The UK is “Not the Only Country Facing Problems”
The UK’s problems should also be put in a global context, says Veitch. The UK is not the only country facing political problems. The US also has a weak and unstable government. The Eurozone may be enjoying an economic renaissance, but still has structural difficulties to address, suffering from a lack of competitiveness and high debt burden. Japan has significant demographic problems. “There is a tendency to overplay the UK’s challenges compared to the rest of the world.”
Ed Smith, asset allocation strategist at Rathbones, also believes that markets, particularly currency markets, are placing too high a probability on a ‘hard’ Brexit. He says: “It is not a foregone conclusion that it will be terrible. That would only happen if there was a very hard Brexit, if there were no significant trade deals outside the EU and if the UK’s departure spurs the Eurozone to work more closely together, in which case there might be capital flight from the UK.”
He says that Rathbones analysis suggests that sterling looks “incredibly cheap” versus other major currencies, particularly versus the Dollar. He adds: “Relative to economic fundamentals, it is as cheap versus the Dollar as it has ever been. Even if you take the most gloomy scenario, the implied exchange rate is still above where sterling is trading today. We are cautious on the UK economy in the short-term, but we are certain sterling will appreciate against most major currencies over a five-year view.” This should give investors a tail wind. The weak currency also means that investing globally is more expensive.
Where Should You Invest?
Deciding where to invest within the UK is more complicated. Much of the UK stock market is international in nature and therefore largely unaffected by the domestic picture. For more domestic stocks, most believe that the UK’s weaknesses are reflected in share prices, but differ on whether this is justified. Veitch believes there will continue to be opportunities, though selectivity is needed to avoid companies where input costs are rising because of the weaker currency: “We see elements of value in the market. There are UK domestic businesses that will perform well if they have the right business model.”
One area of strength for the UK has been the dividend outlook. Moore says that, to date, the weakening outlook has not prompted companies to start cutting dividends. The UK market has also benefited from the mining and financial stocks resuming dividend pay-outs, leaving the overall picture reasonably buoyant. He adds: “The UK market is still paying an average of 3.6%, which is a lot higher than a 10-year government bond.”
The situation in the UK might be as bad as it seems, but equally, a disastrous outcome is not a foregone conclusion and weakness is reflected in stock market valuations. The weaker currency and positive dividend outlook provide investors with some compensation.
