The UK: quids in or call it quits?
Despite relatively modest growth, the UK remains one of the world’s largest economies and a popular place to do business.
3 min read
While there are economic headwinds that undoubtedly affect the investment case, UK equities remain a feature of our portfolios.
Growing but lagging
Chancellor Philip Hammond declared himself “positively Tiggerish” when delivering his Spring Statement, in contrast to last year when his down-beat assessment saw him branded ‘Eeyore’ by the press. Talking of a “turning point” for the UK, he pointed to an upwards revision in GDP growth, a downward revision in the budget deficit and wage growth potentially outpacing inflation within a year.
Despite this enthusiasm, we think it’s important to look at the figures in the broader context. Projected growth of 1.5% for 2018 (an increase on the 1.4% figure in November) and 1.4% in 2019 (unchanged from November) contrast with 2% and 1.9% forecast for Europe and 3.9% for global growth in both years, according to the International Monetary Fund. Current growth is also low against the long-term historical average of around 2%.
Weaker growth reflects a number of different factors coming to a head. The UK has already had strong growth while other economies were faltering. For example, the UK grew by 2.1% in 2013 and 3.1% in 2014, while the eurozone saw growth of 0.2% and 1.6%. In addition, consumer spending growth has softened in the last 18 months as inflation has risen and wage growth has faltered.
Clearly there are challenges for the economy, with a fragile retail sector and Brexit negotiations still being worked through. But while UK GDP growth is behind some of our trading partners, global growth continues to support the UK economy.
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The UK remains one of the world’s largest economies – it was the fifth largest economy in 2016 – and consistently ranks highly in the World Bank’s ‘Ease of Doing Business’ rankings. These are based on 10 regulatory or practical matters that are widely considered important to establishing and running a business.
The UK ranks seventh out of the 190 countries surveyed and is second only to South Korea among the 25 largest economies. It is highly rated for ease of starting a business, dealing with construction and getting permits. The US meanwhile is ranked eighth, Germany 17th and France 29th.
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UK employment also remains strong. The UK has a low ‘tax wedge’ relative to many of its trading partners, which acts as an incentive for UK workers to engage in employment. The tax wedge is the ratio between the taxes paid by a worker and overall cost of employment paid by an employer. For a single person with no children, the UK’s tax wedge is 31% - behind only New Zealand (18%) and Ireland (27%). By contrast the tax wedges for both Germany and France are nearly 50%.
These data show that, despite a sluggish economy in relation to some of our trading partners, the UK remains competitive for business, supporting a long-term investment view.
The investment case
We currently have a neutral view on the UK. This reflects our positive view on equities generally, and current low valuations for UK equity.
About 70% of our UK exposure is through large-cap stocks, which are more exposed to the global economy than small and mid-cap stocks. Robust global growth is supporting prices in the large-cap space, so our allocation can be seen as a play on the global rather than the domestic economy.
We have seen positive relative returns from our mid-cap holdings as well. A number of these companies also have significant exposure to global markets, but perhaps more important is our route to market. We use active managers in this part of the market who pick stocks based on their own research and judgement. In choppy markets, as we’ve seen in the UK recently, active managers tend to do better. In addition small and mid-cap companies tend to be less well-researched than large-caps, so there are more opportunities for active managers to spot a good share that other investors have overlooked.
We have a positive view on sterling, which we see as undervalued on a historical basis. This has been paying off as dollar weakness has seen sterling recover. Higher inflation and the likelihood of a rate rise in the near future – markets are pricing one in for May – have also benefitted sterling, and the slow but steady recovery should see inflation settle around the Bank of England’s 2% target, supporting a continued gradual rise in interest rates.
We recognise that the UK economy faces a tricky few months as Brexit unwinds and the new economic realities become established. But as a large and generally stable economy, the UK is unlikely to lose its place in investment portfolios any time soon.
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