Notes from the Investment Floor: Winter is coming for the UK economy
Richard Buxton appraises the prospects for the global and UK economies, as a variety of challenges present a tough environment for economic growth.
Winter is coming for the UK economy
Richard Buxton, Head of Strategy, UK Alpha, appraises the prospects for the global and UK economies, as a variety of challenges – some disparate, some inter-linked – present a tough environment for economic growth.
I typically take a ‘glass half full’ view of markets and economic prospects, but I confess that recently it has been easier to see the glass as half empty.
Aside from the Omicron variant, the eventual impact of which remains subject to speculation, inflation and interest rates remain the issues of the day. Recent comments1 from Jerome Powell, chair of the Federal Reserve (Fed), in which he seems to have developed a sudden view – perhaps after receiving a word in the ear from politicians – that inflation must now be tackled through tapering monetary stimulus and higher interest rates, suggests to me that he’s driving while looking in the rear-view mirror. After all, job growth is already slower and higher prices have hit consumer sentiment. There is a risk that the Fed will over-correct and hurt demand even more, although the bond market appears to think it will not follow through in any case, as yields have remained stubbornly low.
Looking elsewhere, in China the attempt to slowly let the air out of its over-inflated property market – a tricky procedure even in a tightly managed economy – is proceeding with questionable success, and the collapse in property sales has impacted municipal tax revenues. Meanwhile, energy prices remain high and with the prospect of a cold northern hemisphere winter look set to remain so, perhaps for the long term. The German coalition government has appointed Green party candidates to the economy, energy, and climate ministries, which leads me to doubt whether the Nord Stream 2 pipeline will ever get certified.
In the UK, higher household utility bills and an increase to national insurance in April will clearly have an economic impact, particularly on the lower paid. Arguably this effect will be offset by a reduction in the savings rate, as people who saved excess cash during lockdown revert to old spending habits. I am of the mind, however, that the habit of putting more money aside for a rainy day will be a long-lasting behavioural change. The pandemic has taught businesses and individuals alike a lesson about the benefits of financial resilience.
We read that there are 1.2 million job vacancies in the UK – but will those vacancies ever be filled? We’ve had the departure of swathes of foreign workers who are not coming back, and while a tight labour market does lead to higher wages a lot of that is being eaten up by higher prices. Taking all of this into account, I think the UK will struggle to deliver much economic growth in 2022.
1Jay Powell looks past Omicron threat in hawkish pivot on inflation | Financial Times (ft.com)
A positive outlook for Asia Pacific, but be selective
Jason Pidcock, Head of Strategy, Asian Income, discusses where he sees the best opportunities in the Asia Pacific region, and why he remains cautious about investing in China.
Year to date, we’ve seen that investors in Asia Pacific can be cautious about China while remaining upbeat about the rest of the region. Relative returns for investors in Asia Pacific have been determined by exposure to China, as the Hang Seng China Enterprises Index has returned almost -19% year to date, while Taiwan is +26%, India +22%, Singapore +9.8% and Australia +5.5% (all in sterling terms).
While Chinese equities have fallen sharply this past year, I believe they are cheap for a reason. I remain cautious about China given a range of concerns, from geopolitical risks to significant government interference; I think many events could happen that would see stocks lurch down again. In terms of developments in the Chinese property sector, it does seem that the market is now starting to differentiate between those companies that perpetually need to raise credit and those that are doing so to get their balance sheets in order. This week’s reserve requirement ratio (RRR) cut of 0.5% shows that the Chinese government is concerned about growth, and while the consensus view is for China’s economy to grow around 5% next year, I believe it could be weaker than that, especially given its zero-tolerance policy towards Covid-19.
Looking at the bigger picture, I expect inflation to remain sticky for some time. Concerns have led several central banks to consider, or begin, tightening monetary policy. This backdrop means that owning companies with pricing power is essential, in my view. If input costs rise, companies need to be able to pass these higher costs onto consumers. For that reason, I prefer consumer staples companies to consumer discretionary companies – I think that consumers will pay up when staples become more expensive, but that means there’s less in their pockets for discretionary items.
I also like the technology sector, especially those companies that spend a lot on research & development (R&D), and can finance that spending with strong balance sheets i.e. net cash positions. Taiwan, in particular, is home to some of the world’s most successful and exciting tech companies. I’m wary of companies that must borrow lots of money and to be frugal with their dividend payouts to enable them to invest for the future.
I expect to see growth in dividends from Asia Pacific companies next year, partly due to this year’s earnings growth, as well as likely continued earnings growth next year. While it’s fair to say that some pockets of the region, such as India and New Zealand, are now looking quite expensive, I still believe the region offers up many attractively-valued opportunities for investors, as long as they’re selective.
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