HUB EXCLUSIVES PANEL DISCUSSION
Panel discussion, hosted by Cherry Reynard, with:
Gervais Williams, Head of Equities, Premier Miton Investors
Anna Farmbrough, Portfolio Manager, Ninety One
After a near-decade of political and economic disruption, the UK appears to be entering a period of greater stability. A new government, improving economic data and greater confidence should bring about a better outlook for UK businesses. Will this translate into stronger performance for UK equities?
The UK’s stability is in notable contrast to the disruption being experienced elsewhere. From Trump in the US, to the rise of the Far Right in Europe, it is clear that the world is increasingly disenchanted with the impact of globalisation. Covid accelerated this disillusionment, and it has been a theme running through recent elections across the globe.
Gervais Williams, head of equities at Premier Miton Investors, says: “What was interesting about the UK election is that the first-past-the-post system tends to engender middle of the road parties. We have had a change of government, but the policy change isn’t very significant. If anything, it is possible to argue that the UK is an island of stability ahead of the US election, which could be more disruptive.”
This political stability sits alongside growing economic stability. The UK economy increased by 0.6% from April to June, following an increase of 0.7% in the first quarter . This puts it ahead of much of Europe, and edging closer to the US. The incoming government has put wealth creation at the heart of its ambitions, aiming to improve growth through planning and infrastructure reform.
Anna Farmbrough, a portfolio Manager at Ninety One, says: “Inflation is slowing, wages are rising, so consumers should be feeling a bit better, which – in turn - should stimulate demand and create greater confidence. The most encouraging factor is that UK businesses have never been in better shape. Balance sheets have never been stronger. Profitability and return on invested capital have never been higher. And yet valuations look compelling.”
Falling borrowing costs
The Bank of England has also cut rates, after inflation fell to more manageable levels. The UK market has been seen as a ‘value’ market and therefore a natural beneficiary of lower rates. However, Farmbrough believes the ‘value’ nature of the UK stock market may have been over-stated. In reality, UK companies are far higher quality and less indebted than this tag implies.
“For those sectors that are more capital intensive, lower growth – energy, banks and so on – the barrier to entry is capital, so if the cost of capital falls, you can see more competition. If you’re selling a commoditised product, and there’s supply growth, and prices roll over and profitability rolls over, so you have to be careful. Businesses with genuine pricing power and barriers to entry can be in favour in a lower inflation, lower interest rate environment.”
Williams doesn’t believe low interest rates will necessarily make the difference for small caps either, but their prospects still look good. He believes the inflation environment will be far more unstable from here and that may hurt profit margins for weaker companies. “Profit margins, which are near record levels, will probably normalise back to where they used to be 20-30 years ago. If that happens, most companies will generate less cash, and many of the zombie companies that are already struggling, will probably go bust.”
Nevertheless, he sees this more unsettled environment as good for many UK companies. “The key thing about UK companies is that they’re capital intensive, but they generate surplus cash. When cash starts running low because companies generate lower profit margins, companies generating surplus cash become more valuable. This is why the UK is so interesting right now.”
Fund flows
It is possible that the UK market will see a virtuous circle. Recent surveys have suggested the UK is building momentum with global fund managers. This has been mainly focused on larger companies, but as the market rises, local investors will be drawn back to UK equities, and this in turn would benefit the small cap market.
Williams points out that smaller companies are coming from distressed valuations and have seen considerable selling pressure. If this were to ease even a little, it would be very beneficial for UK smaller companies. “We are tremendously upbeat about the potential for companies to generate good returns from here,” he says.
Sentiment towards the UK appears to be improving. Farmbrough says: “We’re hearing from companies that they feel more positive about investing in the UK. They are positive about the government’s focus on growth, and they’re positive about having a new government after several years of instability and a difficult trading relationship with Europe. This has impacted a lot of businesses, and it is probably easier for a new government to sort that out. Companies are more positive and that’s a great starting point.”
Gervais says the global environment carries significant risks, but UK companies should be on the right side of an unsettled environment. He says the past 30 years has been a “Goldilocks environment” with relatively few setbacks for investors. Today, however, it is different. He adds: “Companies with weak balance sheets, companies that are reliant on stock markets to fund their growth – these companies have very big risks. Zombie companies will go bust. And when they go bust, they may take their suppliers will them.”
However, it will be a good moment for strong, quoted companies. “Being a quoted company in an unsettled world is a major advantage, particularly a cash generative company. There are plenty of risks, they are going to get worse, but many companies that are quoted in the UK are well-positioned.”
