3 December 2020
Buy Britain!
New hope or false dawn for UK equities?
By Frank O’Nomics
As recently as late October the IMF warned that financial markets were at risk of a sharp correction, with the UK considered particularly susceptible given the added uncertainty of Brexit. Since that report FTSE has had its best month since 1989, rallying a jaw-dropping 17%. Now seasoned market players such as Goldman Sachs, Citigroup, Morgan Stanley and UBS have recommended that we buy both UK shares and sterling. Has the announcement of a vaccine fundamentally changed the outlook for stocks, or are they now even more vulnerable?
The IMF opined before the series of announcements regarding vaccine trials, but it is worth revisiting what they said in light of the market reactions to the news from Pfizer, Moderna and AstraZeneca. Prior to the market rally they were worried about “stretched asset valuations” which had been prompted by markets taking ever more risky gambles in the expectation that there would be government bailouts at the first sign of any instability. This raised the risk of a very sharp market correction and periods of extreme and destabilising volatility. They said that policy makers face a trade-off between the support needed today and the “implications for rising vulnerabilities for growth in the medium-term”, emphasizing that “monetary policy should remain accommodative” with a view to ensuring that a recovery is sustainable. The IMF is not alone. The European Central Bank in its recent stability review said that banks are likely to need to set aside more money for bad loan provisions, and the Federal Reserve has also warned of the consequences of over-valued markets.
That the UK economy is in a vulnerable state has been highlighted by the latest news of high street failures. The prospect of both Debenhams and Arcadia closing has put 20,000 jobs at risk, and it is estimated that, so far, 750,000 jobs have been lost as a result of the pandemic. It might reasonably be assumed that UK stocks cannot be attractive with this backdrop, but other elements within the recent data releases suggest otherwise. Despite the high profile failures, aggregate corporate profits have been running at remarkably high levels, with the £128bn figure for the last quarter a record high, and the average quarterly level this year slightly above that of last year. Such data comes with an inevitable warning given the distortions caused by state support schemes. The government is currently paying the wages of some 4.5 million people on furlough and much less has been spent, and hence money saved, by businesses on investment. Corporate health may then be being overstated by such data, but much of the additional help that has been provided by the government has not been needed. The repayment of £585 million of business rates relief that Tesco decided that they did not need may herald similar moves by their competitors. Further, it seems that the loans that many smaller companies took are still sitting in their bank accounts waiting for that rainy day. If that day does not come they too will repay.
Why has the impact of the pandemic not been as severe as feared? The simple answer is that the policy response to the pandemic, both in the UK and in other major developed nations, has been unprecedented. Both fiscal and monetary policy has been employed, with business loans and furlough schemes in the former, and rate cuts and quantitative easing in the latter. Here lies the justification for the investment banks being much more enthusiastic than the likes of the IMF regarding the prospects for equities. The banks see little prospect of those highly supportive policies fading for some time. Despite talks of wealth taxes, capital gains taxes and pension raids in the UK, it is seen as unlikely that the government will do anything to undermine any fragile recovery. This decision is made much easier with borrowing costs so low – the UK can borrow for 30 years at less than 1%.
On a historical basis it is hard to argue that UK equities are particularly cheap. However, on a relative basis, it is possible to contend that they offer value, particularly when compared to the US. While the Dow Jones Industrial Average hovers near its record high, FTSE is still 16% off the best levels of earlier this year. It is notable that many of the most bullish commentators are in fact US banks. They are undoubtedly looking for alternatives to this year’s US star performers, and the obvious place to look is the UK. There is of course still one key area where their view could come unstuck. Goldman Sach’s argument that a “skinny” free trade deal with Europe is likely and will be supportive might be wishful thinking on both counts. Nevertheless, it is a brave man that stands in the way of the “thundering herd”.
tile photo: annie spratt at unsplash
