We have only to cast our minds back a relatively short way, to the end of 2008 to remember the horrible feelings that the financial crisis created and how shocking it was to even suggest buying into stocks in that period - yet the point of maximum fear is often the point of maximum opportunity.
So, what makes the present situation so interesting? Firstly, and rather flippantly, we have had over three years to prepare for this ‘shock!’
The current fear with regards to the general economic outlook and the consequent drop in bond yields implies that we are likely to see further monetary stimulus, either with cuts in interest rates or another round of quantitative easing. The more appealing demographic dynamics of the ‘Anglo-Saxon’ economies suggest that they may have a better chance of responding positively (by triggering an increase in consumption) to such steps than the more aged profile of Japan or Europe, Germany in particular, where a more aged profile is hit by a greater need to save.
This drop in bond yields has been significant with only the UK and USA offering positive yields across the term spectrum.
The fears over Brexit and the ongoing political impasse have pushed the UK to a significant discount versus its peers. Already the FTSE All-Share trades on relatively attractive multiples with the market looking for forward earnings growth of just over 6% and a median yield of 4%. This puts the market on a forward price to earnings multiple of 12.5 times. Even if one tempers the growth rate, the appeal remains.1
Market valuations - forward price/earnings (P/E) 12 months
Source: Fidelity International, FactSet, 15 August 2019
One must remember too, that the UK stock market is a very different beast to the UK economy, with well over 65% of earnings generated overseas. The remaining proportion is heavily domestically exposed, meaning that they are not reliant on cross-border trade, such as banks, utilities or real estate. In fact, very few of the market-related companies are likely to see a direct impact, and my assumption is that many have taken great steps to ensure the hit is mitigated. It is highly likely that the immediate impact of a so-called ‘no-deal’ Brexit will have a more negative impact on non-stock market related areas such as agriculture, education or health.
The UK economy is however in a reasonable position, again relative to its peers, with very little obvious difference. Employment levels remain high, we are seeing good wage growth and inflation appears to be under control.
There is even a chance that the UK may see a ‘mini-bounce’ with a stock build ahead of the exit, the potential for a cut in interest rates, a fiscal boost from tax cuts in addition to a stimulus from a drop in sterling.
An issue to consider for a slightly longer time horizon is that of the diminishing impact of monetary policy. As economies and markets have become almost hooked on the ‘methadone-effect’ to cure financial weakness, the medicine is, perhaps, the factor that is weakening the levels of inflation. As the ‘zombie companies’ are kept alive their excess production serves to dampen pricing levels and also to hinder investment. The better companies do not wish to create excess capacity into this environment or to buy assets at inflated prices - hence dampening inflation and investment - the exact opposite of the intended result.
It is possible that Brexit may offer the freedom to UK policy makers to become a little more innovative in its use of fiscal and monetary policy. The government might finally be able to use the low cost of borrowing to spend on its creaking infrastructure and generate a positive return over its cost of borrowing.
1Peel Hunt, as at 12 August 2019
Important information The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
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