Brexit and the general election
Two fundamental problems have faced investors (and the UK economy) in recent times:
Brexit and the general election.
Most investors have tended to be more focused on Brexit; we have consistently been more concerned about the general election. We now enjoy a huge increase in certainty around outcomes for both.
The UK electorate has roundly rejected a Labour Party whose policy set (philosophical identity and direction of travel) was the most socialist seen in my lifetime and would have been the most aggressively socialist in the developed world. The downside risk for many assets under a Labour victory was significant and, for many, unjustifiable at almost any valuation.
Labour policy was to re-nationalise the utilities and railways, the postal service and much of our telecommunications infrastructure. They had explicit plans for the seizure of 10% of all companies to be redistributed to the workers, mandatory changes to board composition, broad expansion of rights for industrial action and significant increases in corporate taxation.
This was compounded by risks to currency and gilt markets from very aggressive fiscal policies involving significant increases in borrowing to fund day-to-day expenditures. These risks have gone away for the next 5 years and, given the scale of the rejection of these policies, hopefully for many years to follow as we return to far more centrist politics.
Brexit has also been materially de-risked. The crash-out scenario is now removed. The Conservative majority is more than sufficient to approve the latest version of the exit agreement.
The question now moves to (yet more) wrangling over the precise terms of a future trade deal. There will undoubtedly be more brinkmanship to be enjoyed, but having got this far, the compromises likely required by either side compared to the prize on offer, seem unlikely to derail the process.
The good news is that the starting point for negotiations is perfect alignment and significant integration; hopefully encouraging both sides towards a more pragmatic approach.
We also know that the UK's objective is something more akin to the free trade deal agreed by the EU with Canada (ideally with a plus or two). This will undoubtedly create some additional grit in the gears compared to the status quo, but little that seems insurmountable.
We should also bear in mind that the UK's principal exports are services, which are not treated well within the EU frameworks, and that international trade deals become possible. It is not all down-side risk.
What does this mean in practical terms: we expect confidence in the UK to recover, consumer spending to recover and investment spend to perk up. This will lead to positive feedback loops as the currency strengthens, earnings forecasts are increased and risk premia reduced; in turn supporting further increases in confidence and spending.
We believe that sterling is at least 10% undervalued and that UK assets are (in pure, short-term valuation terms) 10-20% undervalued. Probably most importantly, the UK now has an entirely idiosyncratic driver of economic activity at a time when other economies may be slowing, which could drive several years of improving corporate profitability which for many businesses could dwarf the gains to be made from the correction of anomalies in currency and valuation.
A brief look at history
The Thatcher victories
Past performance is not indicative or a guarantee of future returns. Indices are not available for direct investment. Source: FTSE, Mirabaud Asset Management.
Where are we : probably not back in 1979, but there are similarities.
To over simplify history, Margaret Thatcher’s general election victory was primarily on a ‘smash the miners’ ticket. The coal miners and trade unions were holding the UK to ransom, whilst the world was adjusting to the oil shocks (1st in 1973, 2nd in 1979).
The UK’s economy was weak and Thatcher’s election – and capitalist policies - reinvigorated activity, with the equity market beginning its long bull run (arguably ending 20 years later post the TMT bust in 2000, but interrupted by the 1987 crash).
Obviously, the UK’s backdrop isn’t as economically challenging as 1979, but perhaps the EU and Brexit is a little analogous to the miners. Sort the problem (with the authority of a thumping majority) and all will be a lot more positive.
We are very possibly in 1983. Thatcher’s second victory extended the UK’s feeling of prosperity, gave visibility to the ‘runway’ and, of course, global growth was relatively robust with asset price growth gathering momentum post the oil crises (so, today the global backdrop with trade wars is unhelpful to the analogy but the UK is certainly favourably poised to gather momentum).
The 1980’s bull market accelerated with the UK’s zeitgeist encapsulated ~4 years after Thatcher’s 2nd victory in Harry Enfield’s brash catchphrase “loadsamoney” (said whilst flashing wads of cash for all to see). Should the UK negotiate Brexit acceptably, then from a low but resilient base, the UK economy will likely strengthen and relatively and absolutely low domestic asset prices will likely rise, particularly given the removal of the worst of currency risk. Is “loadsamoney” coming back?
Finally we are unlikely to be in 1987 (asset prices, particularly UK ones, aren’t high enough) but even if we are nearer to 1987 (following the longest US expansion in history, an extended US equity market), any global correction will likely be felt least in UK domestic asset prices given the relatively low (de-risked) starting point and the visibility of favourable policy directives following Boris’ emphatic election victory. The outlook for a large swath of the UK equity market has just been de-risked.