The recent UK General Election yielded an unexpected outcome and Prime Minister Theresa May’s intended plan backfired spectacularly. To remain in office, the Conservatives are going to have to accept compromises, in particular regarding Brexit and austerity. With a diminished presence in parliament, the Conservatives will have to water down their policies. This is actually quite reassuring for equity markets as it leads to more moderate outcomes that don’t deviate far from the status quo.
However, the election also brought into focus fragilities in the UK economy. British households are feeling the squeeze, as real wages are falling. Amid this backdrop, it is concerning that GDP is highly dependent on consumer spending. Many people have limited or no savings and meanwhile banks are scaling back their consumer credit businesses, making it harder to access funds.
The market reaction to the UK election was similar to that of Brexit, but to a lesser extent. Sterling sold off, putting pressure on domestic mid-caps such as house builders, challenger banks and consumer-dependent stocks. Helpfully, our UK equity strategy was protected from this as we have reduced the number of mid-cap holdings in recent years.
While the cycle is becoming increasingly long in the tooth, we are still some way off the levels of irrational exuberance that typically characterise the end of a bull market. That said, the UK market is heavily divided. Defensive plays, which enjoy high ratings that appear somewhat extended, are at one end of the spectrum and recovery stocks, which we prefer, are at the other. We seek out those companies that have fallen on tough times and have underperformed but crucially that still have the ability to be rehabilitated. We believe this area is being overlooked and as such offers greater scope for outperformance.