Poor Relation - Article from Partridge Muir & Warren

Poor Relation

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Simon Lewis, CEO of Partridge Muir & Warren, explains why the UK stock market is an international laggard. 

Investors who have followed a UK-centric approach to investment have been served poorly so far this year. Financial markets are global in nature and the performance of the UK stock market has much to do with how overseas investors perceive the UK.

One of the most reliable indications of a nation’s financial health is provided by what is happening to the relative value of its currency. It makes sense to confine such comparisons to similar cultures and economies and if we look specifically at the US and the Eurozone, it is noteworthy that the pound has depreciated by over 25% against both the US dollar and the euro over the last five years. Of course, much of that decline was a consequence of Brexit; the UK suffered a prolonged period of tortuous uncertainty until a withdrawal agreement was finally agreed. Although this issue has subsequently been relegated by other headlines, uncertainty will continue until a new trade agreement is finalised, hopefully before the UK leaves the single market at the year-end.

Coronavirus Confusion

More recently, the UK has been a cause of concern because of its confusing and apparently haphazard strategy for enabling the economy to emerge from the coronavirus lockdown. Such confusion has not been helpful for an economy structured in a way that makes it particularly vulnerable to the restrictions on human contact and movement necessary to control a pandemic. The requirements regarding social distancing are easier to achieve within factories (which have become increasingly automated in recent decades) than in the shops, restaurants and cafes that make up a larger segment of the UK economy.

The current confusion regarding the likely longevity of our contrarian approach to the degree of human separation is not helping. Most other countries have prescribed a 1m separation whereas we have been sticking doggedly to 2m until very recently. Furthermore, the current international travel restrictions are also perplexing.

The UK holds itself out as both a hub for international business and a ‘go-to’ destination for tourists. One of the major narratives of the ‘Get Brexit Done’ mantra was that we be would be free to do business with the rest of the world. In the circumstances, it is not credible to impose a 14-day quarantine requirement on visitors from countries with a lower rate of infection for Covid-19. Now officially virus-free (aside from the occasional visitor from the UK), what do New Zealanders think about our policy?

It goes some way to explain why the OECD has predicted that, at 11.5%, the decline in the UK’s GDP over the course of 2020 will be greater than any other major country. By comparison, the Eurozone and US economies are expected to contract by 9.1% and 7.3% respectively.

A Vote of No Confidence

So far this year, the pound has weakened by over 6% against both the US dollar and the euro. Ordinarily, it would be expected that the weakness of sterling would benefit the earnings of the UK’s largest companies. This is because over three quarters of the revenue of the constituent companies of the FTSE 100 share index is derived overseas, so a weaker pound means an increase in the sterling value of such earnings. However, this effect has not been sufficient to overcome the rout in UK share prices.

The FTSE 100 share index is currently 16% lower than at the start of the year whereas the S&P 500 (which tracks the 500 largest companies in the US) and the Euro Stoxx 50 (50 largest companies in the Eurozone) have fared significantly better.  The Euro Stoxx 50 index is now only 5% lower whilst, remarkably, the S&P 500 is actually up by nearly 3%. The US stock market has bucked the trend because it is laden with large technology companies, many of which have actually benefited from the pandemic.

The Bank of England announced yesterday that it would extend quantitative easing by a further £100 billion. In ordinary times, this would be considered a significant boost to the economy, but global financial markets were disappointed with both the scale and the proposed pace of additional asset purchases (the speed with which the Bank will introduce the money to the economy). Both the pound and UK stock market fell in response.

A Buying Opportunity?

You might be asking yourself whether the much bigger fall in the value of UK shares relative to other equity markets presents a buying opportunity. Our view is that it is too early to make such a bold move because the poor performance of the UK stock market has as much to do with a collapse in corporate earnings, as it does an erosion in confidence. We also remain behind the curve internationally in terms of opening up our economy and are demonstrating an irrational reluctance to allow most of our children to return to school. The latest announcement on tutoring is eye-catching but in reality, where is Government going to find the tutors on which to spend £1 billion? Let’s not forget that it is already paying many teachers a full salary not to teach.

Investors should probably wait until there is greater clarity regarding Government’s policy and I hope that they will not be required to wait much longer. In the meantime, PMW maintains its heavy overseas bias within our client portfolios.

It is understandable that Government is cautious because in the short term, our vociferous and ‘knee-jerk’ media would not forgive it if it allowed the Covid-19 death rate to rise again significantly. However, Government should also consider that it would not be forgiven in the long term if, through delay and indecision, it caused the UK economy to suffer a long-term impairment that negatively affected our nation’s prosperity.

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