John Redwood, chairman of Evercore Pan-Asset’s investment committee, looks at what the coming year could hold for the UK economy…
There has been plenty to worry about in recent months in the UK. Many investors and commentators have told us how much damage a Eurozone collapse could do the fragile UK recovery. Even a prolonged period of Eurozone weakness as they struggle to keep the currency together damages export markets.
The government’s Autumn Statement revealed as we predicted a major downwards revision to its deficit reduction plan, with slower growth in revenues and two extra years to get the deficit under control. There has been plenty of discussion of more austerity. None of this has made a good backdrop for equity investment.
We have been very cautious about the UK. We have typically invested nothing or very little for our discretionary funds in UK shares. Last year demonstrated why, with a year of declines in the Stock market as investors revised their expectations downwards. The prices of shares vindicated our stance. As we entered the new year investors were still worrying about the possibility of a double dip UK recession, the danger of more downward revisions to forecasts, and the further damage which a worsening Euro situation could do.
We now think you can overdo the gloom. This year should bring one good piece of news for the UK. Inflation should at last tumble. As forecasters who have repeatedly warned that the Bank of England has been far too optimistic or complacent about inflation, we now think at last the Bank’s optimism is more justified. Inflation at over 5% did a lot of damage last year. It cut into people’s living standards badly, cutting real domestic demand as real incomes fell. This year we expect a succession of energy price falls, the ending of the VAT effect on prices, intense supermarket and High Street store price competition and pressure on retail margins. This will help get inflation down substantially, relaxing the squeeze on real incomes and limiting the decline of domestic demand.
We also expect the government’s stance to become easier. Credit easing is expected to be rolled out soon. The Chancellor promised it in the Autumn Statement and will have to have it working for around the time of the Budget. He has also promised more capital projects to help the construction industry. London may lose some of its normal tourist business this summer, but will still get a boost from the Olympics. It will be the world city of the year, and will attract some high spending visitors as well as tons of publicity. I doubt the authorities will worry much if the pound weakens a bit more, as in the short term this will not offset the inflation falls and may help exporters a bit. I expect the government to pick up on its promises of promoting recovery, and to find actions in the budget that reflect the words of the Autumn Statement.
The London market is not expensive on yield or P/E grounds at 3.3% and 10.8. There are still things to worry about. The UK public finances still are in a weak shape. Euroland is far from resolved. The UK is going to experience slower growth for some years as it gets over the massive debt hang-over in both the public and private sectors. Retail rents have further to fall, and office properties outside London are not a great investment. Nonetheless, at the margin we are less negative than we were. This is because shares are now cheaper, investors are more pessimistic, and some things, especially inflation, are beginning to go right.