Head - EMEA Investment Strategy
May 4, 2018
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Weaker global trade fears along with Brexit uncertainty are beginning to weigh
The UK’s first quarter GDP growth slowed significantly to 0.1%, missing estimates of 0.3% and well below the fourth quarter reading of 0.4%. This places the year-on year GDP figure at 1.2%, below previous consensus estimates of 1.4%.
The UK is now growing at its slowest pace in six years and is the world’s slowest growing major economy. The manufacturing sector expansion is now slowing, with the Purchasing Managers’ Index down to 53.9 in April from 54.9 in March, as Sterling’s strength and weaker European growth begin to have impact.
In addition, there is now a clear broad-based decline in the growth of the money supply and in lending to UK consumers. A key component of this – car finance – is showing a 14.5% rise in loan repayments, resulting in a 15.7% year-on-year fall in new car sales. With both manufacturing and consumption weakening, we conclude that the combination of weaker global trade fears along with Brexit uncertainty are beginning to weigh on confidence which is adversely affecting corporate investment and consumer spending.
With this challenging environment expected to get tougher, the Bank of England is under great pressure in trying to normalise the rate structure. It next meets on 10 May, and Citi Research is not expecting a rate hike. The market implied probability of a second rate hike this month has fallen to 16%.
The Global Investment Committee maintains a neutral allocation to UK large caps, whilst being cautious on mid-caps, which are more exposed to the UK’s domestic slowdown. Large caps in the UK generate approximately 70% of their revenues from overseas. The yield gap with fixed income offers further support.
While the market is under-owned and inexpensive on 16X historic earnings and 14X prospective earnings, our preference is to be very selective at the individual stock level, focusing on companies which have high free cash flow, dividend yields over 3%, and emerging market revenues.
There are two factors likely to hold the index back in the coming months: Firstly, the inability for investors to perform rigorous long-term sectoral analysis upon the UK until specific conclusions from the EU discussions are reached, which will be many months away.
Secondly, there are significant Brexit-related hurdles in the next few months. Unfortunately, this political risk comes as economic challenges mount, most notably in the retail and property sectors. This is likely to raise the risk premium and volatility of UK equities.