The UK economy heads into 2014 on a fair wind amid increasing evidence that wages are finally catching up with inflation and companies are becoming more willing to invest in their businesses, says Steve Davies, co-manager of the Jupiter UK Growth Fund and manager of the Jupiter Undervalued Assets Fund…
No matter that the UK economy grew at its fastest pace in three years in the third quarter, sceptics of the recovery are only too happy to flag the ongoing squeeze in real wages and the lack of business investment as evidence that the revival in Britain’s fortunes could yet prove short lived. There are, however, increasing signs that these two hurdles to a sustainable recovery are being removed, making the UK potentially one of the most attractive markets for stock investors in 2014. Rising real wages, in particular, are likely to be a boon for UK companies with a focus on the domestic consumer.
The most compelling evidence that UK wages are finally beginning to outpace inflation comes from a monthly report on take-home pay from Vocalink, one of the country’s largest payments systems companies. In its latest report, take-home pay rose 2.4% in the three months to November, with the country’s all-important services sector seeing even faster growth of 2.7% over the same period1. At the same time, UK consumer price inflation fell in November to a four-year low of 2.1%. While the official data on average earnings paint a gloomier picture, with earnings up 0.9% compared to a year ago, these figures do not take into the account the impact of the increase in personal tax-free allowances or the cut in the top-rate of income tax in April 2013. As such, we believe that the Vocalink report offers a more accurate picture, and one that clearly shows that those in work are now seeing their pay rise faster than the cost of living. Further support to this view comes from ASDA’s latest Income Tracker for November, which shows that discretionary income (ie after spending on essentials like food and utilities) is rising again after a sluggish spell during the summer.
On top of this, the latest unemployment figures provide further grounds for optimism for investors in well-run, domestically-focused businesses such as banks, retailers, TV broadcasters and house-builders. Unemployment fell to 7.4% in November, its lowest level since 2009 yet this figure, a three-month rolling average, fails to convey the pace at which people have been finding jobs in recent months. A month-by-month analysis shows the jobless rate actually fell to 7.0% in October from 8.0% in August, effectively taking some 300,000 people out of unemployment in the space of just two months. More people in work can only bode well for consumer spending levels.
Business investment, meanwhile, has been showing signs of picking up steam, rising by an estimated £600m or 2.0% in in the third quarter compared to the previous three months. This is still some 5% lower than the equivalent figure in 2012 and we have, admittedly, had false dawns in this data series in the past. We will nevertheless watch the next quarter’s data with interest as another positive number would point to momentum building in an area of the UK economy that has up to now has lagged the recovery seen elsewhere.
A threat, of course, to our positive outlook is the chance interest rates may start to rise in 2014. We feel such a move remains unlikely even if unemployment is falling faster than initially anticipated and coming closer to the threshold level of 7% when the Bank of England will start to think about the need for a rate increase. With inflation starting to ebb away (and we may see further downward pressure on food prices if competition in the food retail sector heats up further), we expect the MPC to ignore the 7% threshold and look again if and when unemployment drops to 6.5%. Incidentally, this latter figure is the same target level being employed by the Federal Reserve in the USA. Even in 2015, when rate hikes might well happen, we think the Bank of England will also deploy other tools to moderate excess growth in specific areas of the economy, most notably excessive house price inflation in London and the South East. As a result, it might mean that the rate of increase in interest rates might not be as fast as in the past and the “equilibrium” level of rates, typically thought to be around 4-5%, may indeed be lower than before if these other tools are being deployed alongside.
Finally, the second risk to our positive stance on domestic UK names is the uncertainty surrounding the outcome of a general election that is now less than 18 months away. We cannot second guess what policies the main political parties might champion that may or may not be detrimental to our investment strategy. We do believe however that the current political battle over the cost of living can only result in more money going into people’s pockets in the run-up to the election. Higher disposal income, whether it is the result of George Osborne increasing personal tax-free allowances or government pressure on power companies to lower energy bills, can only be beneficial for the UK companies we own.
It is important to note that due to the Funds sector requirement to have 80% of the Funds invested in the UK the Jupiter UK Growth and Undervalued Assets Funds have a much greater proportion of their assets invested in UK domestic sectors than the overall FTSE All-share index, which is still dominated by big weightings in commodity sectors such as oil & gas and mining. Some of the most significant UK domestic holdings in the two Funds include Lloyds and Barclays, general retailers Dixons and WH Smith, house builder Taylor Wimpey and travel company Thomas Cook.
This focus on UK domestic funds has helped the £972m Jupiter UK Growth Fund deliver returns of 31.5% year-to-30 November. It is also a top quartile performer in the IMA UK All Companies sector over 1, 3, 5 and 10 years.