Monday, July 04, 2016
Chris Morrison, investment manager, explains his views on the UK’s recent referendum result and its potential impact on the UK economy and equity market.
In hindsight, it was the market’s rose-tinted wishful thinking that was most surprising. The City was wrong-footed, underestimating the rising trend of anti-establishment politics. Worryingly, with national votes across Italy, Holland, France and Germany over the next 18 months, this political uncertainty looks set to rise. It clearly doesn’t bode well that only last month, a Pew poll showed that the main economies of Europe viewed the EU unfavourably. Starkly, it also revealed that the poor are more worried than the rich.
Aside from the political disorder, another concern is the outlook for the UK economy, where a slowdown during the second half of this year and into the next seems increasingly likely. While there has been much debate over the impact on net exports and investment spending, the elephant in the room is consumption. This accounts for the lion’s share of aggregate demand and is highly susceptible to waning sentiment and lacklustre real wage growth. Adding fuel to the fire, the government is still piling up national debt and worse still the current account deficit is at record levels. But if the economy does slow, Mark Carney has made it clear that the Bank of England stands ready to provide stimulus. Clearly this would be unwelcome news for savers but it could provide an important cushioning effect for economic activity.
Before you reach for the strong stuff, the outlook for the UK equity market is more nuanced because prospects for company earnings, in particular the all-important large caps, are impacted only at the margin. Collectively, the FTSE 100 names generate approximately three-quarters of their money beyond these shores. The weaker the pound, the greater is the boost from foreign earnings. Moreover, for those large-cap stalwarts with multi-decade life spans, short term volatility has a relatively insignificant impact on their intrinsic value.
Also, let’s not forget that privately-owned UK companies are cash-rich, which cannot be said for many of their international counterparts. While the current uncertainty may postpone investment decisions, at some point this excess cash will be spent. Ironically, the vote may end up causing more damage in the eurozone than it does in Britain. Granted, the more domestically focused FTSE 250 has experienced weakness but, as we have been saying for some time, this index has been due a correction on valuation grounds. Furthermore, this index represents less than one fifth of the FTSE All-Share, in terms of market capitalisation.
In terms of our approach in the UK equity strategy, we are looking to add to positions where sentiment has depressed stock prices to levels well below our estimate of intrinsic value. At the same time, given the uncertain environment, we feel comfortable maintaining our higher than average cash balance. We have benefited from moving into gold and silver, and are happy to maintain these positions for now.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.