If ever you fear that a project you’ve toiled on has been a fool’s errand, take comfort that at least you didn’t manage this summer’s Conservative leadership contest.
It surely fell to someone to arrange a series of debates, hustings and votes over a period of eight weeks. Liz Truss’s stint as Prime Minister then lasted… seven weeks.
And the other candidate ended up becoming leader anyway!
So here we all find ourselves, dealing with the fallout of the latest chapter of Britain’s rolling political psychodrama. Now we must contemplate what Rishi’s reign will hold, after the short-lived time of Truss.
First, the good news: the markets appear to have rather taken to the new PM, perhaps unsurprisingly as he is a former chancellor, Goldman Sachs alumnus and hedge fund partner. Since it became clear that Sunak would win the latest contest, government borrowing costs have fallen markedly and Sterling has strengthened against a range of international currencies.
This has helped buy the new government a little breathing space. It has used this to push back the date of the next fiscal statement from Hallowe’en (which was perhaps just a little too on the nose) into mid-November. However, this still looks set to be a fiendishly difficult set piece for Mr Sunak and the chancellor, Jeremy Hunt.
Although no official estimate has yet been published, rough calculations suggest that around £50bn of austerity measures – spending cuts, tax rises or both – will be needed if the government is going to meet its own rules on spending and debt. This is an enormous amount: equivalent to around 2% of the size of the entire economy, or just under 5% of all government spending.
And this takes us right back to the extremely tricky trade-off which dominated the Conservative leadership contest over the summer. Liz Truss focused on promoting economic growth, with Mr Sunak criticising the implications of her plan for inflation and stability. Now he plans to firmly grip the latter priorities, as he always promised – but faces the uncomfortable reality that he will be reducing economic demand straight into a recession, which Ms Truss criticised.
Already there are signs that all is not well in UK plc. The Bank of England believes that the UK has already entered a long and moderately deep recession – a projection published at the same time as the biggest hike in rates for three decades. House prices are now falling in real terms, according to the latest survey from lender Nationwide, with the number of mortgage approvals also turning down. Meanwhile, consumer confidence continues to bump along close to the lowest level ever recorded in market research firm Growth from Knowledge’s regular survey.
While further austerity might cheer the bond markets, it goes without saying that it’s unlikely to perk up data points like these. How so? For one clear example, the squeeze on public sector pay looks set to be tightened, reducing real incomes for millions of workers.
Even the one potential silver lining – lower mortgage rates courtesy of reduced government borrowing costs – seems unlikely to materialise at this juncture. It’s noteworthy that interest rate swaps are now already trading at levels well below those reached in the days immediately after September’s chaotic ‘mini Budget’, yet providers have declined to reduce mortgage rates in tandem. Some will criticise this as profiteering, yet it probably reflects the fact that lenders know the Bank of England is set to continue raising rates anyway.
Clearly then the UK economy faces a multitude of issues (including several others we have not had space to cover here, including a worsening trade balance, unresolved issues around Brexit and weak productivity growth to name a few).
How do investors feel about all this?
The answer is: ‘not good’. As recently as six years ago, UK stocks traded in line with the global market in terms of the forward price-to-earnings multiple. Yet today, the MSCI UK index trades at around a 40% discount to MSCI World on this measure.
Sentiment towards the UK is plainly cowed. Yet it’s just this rejection by many investors that could represent an excellent opportunity for others. This is arguably particularly the case for small- and mid-sized companies.
In contrast to the resilient performance of the FTSE 100, which has benefited from its heavy representation of ‘value’ sectors and international earners, smaller caps have sold off heavily this year as storm clouds have gathered over the domestic economy.
It will be worth watching as to how the next few days unfold. Keep a close eye as to how the financial statement on 17 November is received by markets. See if it includes much help for the lower paid, which could help keep consumer spending turning. A higher windfall tax on energy firms might pick up some of the slack in terms of the austerity required. Falling gas prices might do the same, by easing the projected costs of the government’s Energy Price Guarantee.
In any event, for those with strong stomachs and long-term time horizons, the moment of maximum pessimism could be close.
Indeed, it just might be that a little time spent planning for a potential increase in exposure to the UK market turns out to be a worthwhile and productive use of time. More so than organising a Conservative leadership contest, at any rate…
