Market Bulletin (28/11/2017)
Noises off
Philip Hammond couldn’t complain of a lack of advice. Although he was the star of the show, there were plenty of advance directions shouted from offstage by some of the more truculent members of his own Party. Some went so far as to warn his job was on the line.
In the end, ‘Box Office Phil’ seemed to pull off a reasonable performance, if the reaction from his own backbenches is anything to go by. He managed to sound almost chipper about Brexit, threw in a few jokes, and navigated the delicate balancing act of showing budgetary resolve while also increasing spending. He could certainly not be accused of undue radicalism.
Beneath all the despatch box bluster, however, lay bad news. The independent Office for Budget Responsibility (OBR) cut economic growth forecasts severely – the UK’s growth projections are now comfortably below those of all other G7 countries. Slack productivity growth was the chief culprit, as the OBR slashed projected productivity growth from 1.7% to 1%. Earnings growth was another lowlight. In his response, Paul Johnson, director of the Institute for Fiscal Studies (IFS) said of these three that they “all make for pretty grim reading…we are losing two decades of earnings growth – even to be considering that as a possibility really is truly astonishing.” He was not alone in his views.
“The Budget was most notable for the gloomy economic forecasts from the OBR, which suggested that growth will be 1.6% a year at best over the next five years, implying that the government will still be running a sizeable budget deficit in 2022,” said Nick Purves of RWC Partners. “In addition, the forecasts imply that real earnings will not return to their 2008 level until 2025, which is the longest sustained fall in living standards for UK households for 60 years. Taken together, these imply that both government and consumer spending will be constrained for the foreseeable future, with obvious implications for companies exposed to these areas.”
Not all onlookers were convinced that the OBR had got its forecasts right, however. Martin Wolf, the veteran economic commentator, believed they may have been too optimistic, while Neil Woodford argued they had erred on the side of caution.
“The OBR has been wrong on productivity over the past five years, and as far as I can see, there’s no reason to believe that they will get it right over the next five years,” said Woodford. “Indeed, productivity actually went up in the last quarter so, although one data point doesn’t necessarily point to ongoing improvements, it is entirely plausible that the OBR has made this change at precisely the wrong time. As well as the explicit caution in its assumptions around productivity, there also appears to be some implicit caution around the impact of Brexit on the UK economy. [But] the UK economy can do better than what has been forecast by the OBR – I expect UK economic growth to be in the region of 2% per annum over the next three-to-five years.”
Elsewhere, there was some encouragement in the form of improved retail sales, which had suffered a steep drop a month earlier. Conversely, there were declines in both business investment and consumer confidence – the latter struck a post-referendum low. Monthly data showed manufacturing sentiment improving and construction sentiment declining. Mortgage approvals fell to a 14-month low.
Although the Budget included significant giveaways for first-time buyers, increased investment for science and infrastructure, and a £3 billion Brexit fund, the IFS concluded: “This is not the end of austerity. It’s not even almost the end of austerity.” It calculated that, healthcare aside, public sector spending was falling by more than 6%. For chancellors, of course, the best ally they can have for most problems is a decent level of economic growth. Conversely, the sliding projections mean that the former target of balancing the budget in the mid-2020s now looks ambitious. The IFS calculated that, based on the new growth forecasts, the UK wouldn’t bring debt down to pre-crisis levels until after the 2060s.
Yet broader growth projections aside, many onlookers will simply be relieved that he avoided tinkering too much – and made a few allowances for inflation. Some Income Tax levels were raised in line with inflation, taking the Personal Allowance up to £11,850 and the higher rate threshold (or 40% rate) up to £46,350.
One pot the chancellor refrained from raiding was pension allowances. In fact, for the first time in seven years, the lifetime allowance on pension contributions was actually raised – with effect from April – as had already been trailed. The £30,000 increase takes the ceiling from £1 million to £1.03 million, in line with consumer price inflation. A £1 million pension pot is increasingly common and, if the cumulative value of an individual’s payouts now exceeds £1 million, he or she will face 55% tax on the rest. There are, however, other ways of saving for retirement, including ISAs and using income to fund someone else’s pension pot.
Moving on
If Westminster was filled the noise of politics, investors apparently couldn’t hear it. In fact, for some two decades neither domestic stocks nor gilts nor sterling have offered material responses to the Budget. Last week was little different, although housebuilders saw some pressure due to the chancellor announcing a crackdown on housebuilders that buy land only to sit on it – his mention of “direct intervention compulsory purchase powers” was never going to sound appealing. The FTSE 100 rose 0.39% over the week.
Yet the most significant mover on UK markets the day after the Budget was Centrica, owner of British Gas. The company lurched downwards more than 15%, the largest single-day decline in its history, after it reported that annual profits would miss expectations. Problems with its North American business and the loss of hundreds of thousands of customers at British Gas lay behind the revision to the outlook.
“It’s been a tough year for Centrica, with their shares having fallen by over 35% as a result of three issues,” said Nick Purves of RWC. “Firstly, having lost its majority earlier in the year, the government is trying to win popularity by putting pressure on the energy providers with proposals to introduce price caps on standard variable tariffs. Secondly, and in contrast to the government’s view that the market is not competitive, Centrica has been losing customers at a rapid rate in their home market. Finally, its US markets have also become significantly more competitive and it has also started to lose market share overseas. Unsurprisingly, the share price has reacted negatively to the reduction in earnings forecasts but now trade at a very depressed level, with a free cash flow yield above 12% and a dividend yield over 8%. Any signs of stabilisation in the core business could cause the shares to respond positively.”
Markets globally faced larger pressures, however, as stocks in China suffered their worst single-day sell-off in 17 months, due in part to rising bond yields and the introduction of tougher corporate regulations by the Chinese government. Investors have much larger concerns over China too. “We are a little bit worried about consumer debt in China although not, thankfully, at the corporate level,” said Alistair Thompson of First State Stewart Asia.
Stocks in US and Europe performed well. The S&P 500 ended the week up 0.92%, and crossed the 2,600 threshold for the first time, powered by healthcare and technology stocks. In Europe, the release of the European Central Bank minutes offered investors reassurance over both the economic outlook and the level of ECB support, while indicators for both business activity and jobs growth continued to move in the right direction. The Eurofirst 300 ended the period up 0.71%.
After European markets had closed, news emerged that Germany’s SPD, the chief opposition party, had performed a volte-face in order to negotiate a grand coalition with Angela Merkel’s centre-right CDU. A grand coalition could return Germany to political normality – anything less might have major implications for both the EU and the UK’s EU exit process.
First State Stewart Asia, RWC Partners and Woodford Investment Management are fund managers for St. James’s Place.
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