How a lifetime has suddenly passed in politics: our UK Equity Market Review
When we last wrote our UK Equity Market Review, there seemed no prospect that the destabilising impact of a general election campaign would intrude on market assumptions. Even once Theresa May made her doomed decision three months ago to call a snap poll, it seemed unlikely that the outcome would be anything other than an enlarged Conservative Party majority.
A week or 12 is a lifetime in politics though and absolute age for the markets. We’re digesting the shock election result and trying to establish whether the hung parliament we must now endure can last for long, whether policy will change significantly and, if so, how this will impact our clients’ investments. What is clear of course is that the Prime Minister’s desire for a strong and stable mandate has been dashed and replaced with a weakened and, indeed, wobbly minority administration. She stumbled badly in calling an election which most of the electorate didn’t want. Despite our reticence, another trip to the polling stations seems likely, soon, perhaps before the end of the year.
As we make clear in this UK Equity Market Review, the resultant political uncertainty is badly timed. The UK economy had already begun to slow this year, against the backdrop of an over-extended consumer and the uncertainties surrounding Brexit. This is despite unemployment being at low levels and the fall in the value of the pound having helped exporters.
A slew of weak economic data since the end of March seems to presage a period of greater hardship, with inflation eating into real earnings and the level of household savings at historically low levels. There are also signs that the Brexit negotiating process is causing companies to hold back on investment decisions. This mixture, combined with post-election jitters, is likely to keep the Bank of England from raising rates from their ultra-low levels, until 2018 at the earliest.
So how we must ask, are other global economies performing in comparison to the UK equity market? Frankly, the performance of economies elsewhere in the world has been getting stronger – even if weather-related items have temporarily slowed US growth and, some of the optimism surrounding the Trump agenda has worn off. In mainland Europe too, there appears to be solid upward momentum combined, in stark contrast to us here in the UK, with lower political risk.
As if to emphasise the divergence between the UK and the rest of the world, GDP growth in the UK was the weakest of all the G7 group of leading world economies in the first quarter of 2017, a trend unlikely to be improved in the aftermath of our election.
But what UK-listed companies, if any, have benefited from the improved growth environment outside the UK?
In this UK Equity Market Review we can identify that, with around 70% of profits derived from outside the UK, companies listed in London have been able to actually benefit from the improved global growth environment. Annualised earnings growth among the FTSE 100 companies is forecast to be robust, at around 8% for the next year. Although the FTSE 250 index of smaller, more UK-dependent companies is currently forecast to show equivalent growth of 9%, we’d expect this number to come down over the next few months.
But has the changing environment presented new opportunities? Put simply, it has prompted a sharp rotation within the UK equity market, in terms of both company size and sector. Year to date, the FTSE 100 is up around 7%, while the FTSE 250 is up 11% – a reversal of the trend in 2016, when larger, more international companies did best. However, the election campaign and, Labour’s much better than expected showing in it, has meant that the FTSE 100 has outperformed the FTSE 250 since the election was called.
In sector terms, we can identify that more defensive areas of the market (apart from utilities, which both Labour and the Tories seem intent on bashing) have tended to perform more strongly. The best area has been the personal and household goods sector, which contains strong cash flow-generating names like BATS, Reckitt Benckiser and Unilever.
We’ve taken advantage of these rotations, and highlight through this UK Equity Market Review, that we have added more exposure to companies we like at better valuations, such as Compass Group, Reckitt Benckiser, Carnival and RPC. These have tended to be international in nature and should be relatively insulated from the Brexit-induced travails that we expect to beset UK plc, for the next two years or more.
And the outlook for UK equities over the coming months? Well, that outlook will likely hinge on a return to political stability and clarity over the Brexit negotiations. We don’t see this as particularly likely over the rest of 2017 or indeed 2018. This environment is likely to weigh on sterling, so there are natural headwinds to significant progress from UK-centred companies. Larger companies, on the other hand, may well benefit from the weaker pound, just as they did in 2016. However, any volatility during the fraught conversations between the UK government and our EU friends may well present opportunities for us to exploit. As always, we’ll stay alert to them as they arise.
Your capital is at risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested.
The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity.
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IMPORTANT: Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.