A potent mix of weak growth, high inflation and a fresh bout of political instability means no respite in sight for UK assets struggling to find investor interest.
UK stocks, bonds and the pound are all feeling the unease this summer, and optimism about an improving outlook remains mixed after Boris Johnson announced he would step down as UK Prime Minister.
Laura Foll, a fund manager who focuses on the UK market, for example, says she can name many UK companies whose shares are cheap. But few others see it that way, she says.
“We find companies that are very undervalued compared to where they have historically traded, but that’s not helping the stock price. There just isn’t that marginal buyer,” the Janus director said. Henderson Investors.
Whoever succeeds Johnson faces a very uncertain economic backdrop that looks more challenging than in other developed countries, regardless of how politics plays out.
Although some investors expect a new government to trigger populist spending measures to bolster support, there is limited room to maneuver given the inflationary heat in the economy.
The pound, at a two-year low against the dollar, shrugged at Johnson’s resignation, suggesting that after months of scandal and instability, British politics has lost the power to shock markets.
“Boris Johnson’s resignation doesn’t change much of the macro reality of the UK or the reality of the pound market,” said Tim Graf, head of EMEA macro strategy at State Street. “The toxic mix of rising household costs…and slowing growth should test any future leader.”
Foreign investors have been voting with their feet since Britain’s 2016 referendum to leave the European Union, and there has been no letting up. In the first six months of 2022, investors withdrew £11.3 billion net from UK equity funds, Lipper data showed, their biggest half-yearly outflow on record.
By contrast, global equity funds, also weakened by rising interest rates, received net investment inflows of 31.3 billion pounds, according to Lipper.
Investor outflows are particularly bad news at a time when Britain’s trade strength has weakened. It racked up a record balance of payments deficit in the first quarter of the year of 8.3% of gross domestic product, a figure subject to revision.
The International Monetary Fund predicts that Britain will be the worst economic performer in the G7 in 2023.
“The economic situation in the UK is quite frightening. I think we are on course to have the worst performance in the G7, maybe even the G20, going forward,” said Mark Peden, investment manager, global equities, at Aegon Asset Management.
“I certainly wouldn’t be exposed to the UK consumer at all.”
With inflation set to hit 11% in 2022, consumers are indeed reining in spending, with retailers such as home appliance retailer Currys and supermarket Sainsbury warning of falling sales this week.
The commodity-heavy FTSE 100 outperformed broader stock markets in 2022, but the more UK-focused smaller-company FTSE 250 index fell 20%, in line with the MSCI World index.
Funds invested in UK small- and mid-caps have suffered year-to-date net outflows of £3.2 billion, according to Lipper, more than in any year since at least 2000.
There are also headwinds for the FTSE 100 if the deteriorating global situation hurts commodity prices.
“If there is a global recession, the FTSE will also suffer the consequences,” said Salman Baig, portfolio manager at asset manager Unigestion.
Seeing inflation and interest rates on the rise for decades, investors have also dumped UK bonds this year, eVestment data shows – although this is a trend seen globally, with investors dumping fixed income assets.
A new UK government could implement tax cuts and spending increases to spur growth and woo voters. But as the Office for Budget Responsibility warned on Thursday, Britain’s debt burden could more than triple over the next 50 years to 320% of annual GDP unless taxes are raised.
This leaves the BoE in an unenviable position. Governor Andrew Bailey said inflation in the UK will remain elevated longer than in other economies, even as economic momentum slows.
Even after its 12% drop since the start of the year, speculators are betting that the pound will fall further, as shown by positioning data from the Commodity Futures Trading Commission.
Sunil Krishnan, head of multi-asset funds at Aviva Investors, bought UK government bonds, believing the BoE will pause in the rise before rates approach levels of up to 3% by March next year, as the market predicts.
Every central banker is walking a tightrope trying to tame inflation without triggering a recession, Krishnan told Reuters, but in Britain that tightrope is “even tighter and more wobbly”.
Source: Reuters (additional reporting by Samuel Indyk; editing by Sujata Rao and Deepa Babington)