January 2020: your client asks....what does the election result mean for UK markets and the economy?
UK stocks rallied in response to the Conservative party’s success in the recent UK election. The FTSE 100 rose 1.1% the day after the vote while the FTSE 250, which includes many smaller companies with a more domestic focus, rose 3.4%.
The market reaction reflects greater certainty over the near-term path of Brexit: the UK is set to leave the EU by the end of this month. However, this will not be the end of “getting Brexit done.” The UK must still negotiate new trading agreements with the EU and the rest of the world.
Since the election, Boris Johnson has said that his government will seek to prevent any extension of transitional trading arrangements beyond 2020. This raises the risk of a “no trade deal” Brexit, causing the pound to surrender its post-election gains and UK stocks to retreat slightly.
Where now for UK markets?
UK equities have been an unloved asset class since the Brexit referendum in 2016. Over the past three and a half years, they underperformed global peers by almost 20% and look relatively cheap in an international context. At the start of December, the FTSE All Share traded at a multiple of approximately 13 times forecast earnings for the year ahead, a discount of some 20% to the MSCI World index.
UK has lagged global markets
Source: Refinitiv Datastream
Heading into the election, many global investors – including asset managers, insurance companies and pension funds – had underweight positions in UK shares, given the high level of political risk. The clear election result, with a large majority for the government, removes some of the uncertainty and may encourage these investors to increase allocations to the UK over the coming months.
However, it is unlikely that the valuation discount will disappear entirely. Political risk has not gone away. Though Boris Johnson’s large majority strengthens his negotiating position, it is far from clear what a new trade deal with the EU will look like – or whether one will be agreed in the required timeframe. It also reflects factors other than politics. US – and global – stock markets have been fuelled by healthy earnings growth at technology giants such as Amazon, Facebook and Microsoft. The largest companies in the UK, by contrast, are oil majors and banks, which operate in a much more challenged environment.
On balance, we think the UK equity market looks attractive from an asset allocation perspective. It trades at a significant discount to global markets, while still offering modest earnings growth. It should also be fertile hunting ground for stock pickers, with the UK’s evolving outlook likely to create new winners and losers in the equity markets.
And the economy ?
Increased certainty over the near-term outlook of Brexit could well provide a short-term boost to the economy. Janet Mui, Cazenove Capital's Global Economist, anticipates an uptick in business confidence and spending. However, given continued uncertainty around the UK’s future trading relationships, she does not expect companies to significantly increase their capital spending.
We forecast a rise in UK GDP growth to a very modest 1% in 2020, accelerating towards 2% in 2021 as a result of higher government spending. Thanks to a slightly stronger pound, headline inflation is likely to remain below the Bank of England's 2% target.
"Although the Bank is keen to normalise policy, there is little urgency to increase interest rates if inflation is expected to remain benign,” explains Mui. “If global as well as domestic growth shows signs of recovery, we think the Bank may raise rates once in 2020."
This article is issued by Cazenove Capital which is part of the Schroder Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.