Andy Burnham has a busy summer ahead, deciding on yet another set of priorities for yet another government – the seventh in a decade. While his Chancellor John Healey has promised a “straightforward, well-managed Budget this autumn,” sticking well within the fiscal rules, potential shifts in tax and spending create more uncertainty for UK companies and investors. Stability remains elusive.
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As the Burnham premiership unfolds, the most vulnerable spots are likely to be the UK bond market, and small and mid-cap companies. The two are interlinked. High bond yields throw out the Government’s fiscal calculations and require either tax rises or spending cuts. Both make economic growth less likely, which in turn affects the backdrop for domestically-focused UK small and mid-caps. Smaller-company performance has shown a negative correlation with higher bond yields*.
UK bond markets were already fragile in the wake of renewed tensions in the Middle East. There has been an expectation that higher energy costs will drive inflation higher and 10-year bond yields are now hovering at around 5%**. Investors appear not to have been reassured by recent inflation data, which has been persistently below forecasts. However, the UK is not alone – bond yields have been rising in the US and Europe as well – suggesting it is more the global political situation than domestic troubles that are worrying investors.
Equally, any concerns on the incoming government have not yet shown up in UK small and mid-cap equity performance. If anything, the UK stock market has been surprisingly resilient in the face of yet another change of government. After a difficult period at the start of the year, the FTSE 250 is up 9.45% over the past three months and the FTSE UK Small Cap up 9.11%***. This beats the performance of the FTSE 100, which is up 5.66%. Perhaps more significantly, mid-cap performance is ahead of the S&P 500, which is up 8.30% over the same period***.
Resilient markets, lingering risks
Nevertheless, Richard Hallett, manager of IFSL Marlborough Multi-Cap Growth, says there remain headwinds for small and mid-cap companies, with weaker PMI data pointing to a slowing economy. He adds: “Headwinds include higher taxes, increasing regulatory pressures and a broader deterioration in market sentiment amid concerns over the likely policies of Andy Burnham.”
He says that some companies have already been hit. “Underperformers included outsourcing company Capita, which gave back some of the previous month’s gains amid renewed concerns surrounding its civil service pensions and comments from Andy Burnham regarding increased oversight of public sector outsourcing contracts.” His view is that this is largely background noise and unlikely to be significant relative to the operational restructuring and financial improvements being delivered by the business.
Paul Marriage, manager of the Premier Miton Tellworth UK Smaller Companies fund, says the market has given Andy Burnham the benefit of the doubt for now. “It may just be that a few tweaks to economic policy and a little more political stability is enough to keep the market happy for now”. He suggests factors such as peace, or otherwise, in the Middle East and concerns over the AI investment-led tech boom bursting could have a more significant effect on the market.
Budget worries
There are certainly risks around the first budget, scheduled for 28 October. Last year’s budget was a horror show of rumour and speculation. Kites were flown about potential new policies, which created real disruption. Particularly damaging were rumours about changes to the tax-free lump sum on pensions. As it was, the Chancellor did not enact most of the rumoured changes, but investors felt like they had been put through the wringer.
Paul says this could happen again: “Undoubtedly, the summer will be peppered with various tax-raising schemes which will scare the living daylights out of rational capitalists, but we’ll probably end up with something not as bad as feared.” The one hope is that Chancellor Healey appears to recognise the problem and may not let treasury officials brief the media on every idea considered behind closed doors.
Healey also appears to recognise the burden that has been placed on businesses. At a recent event, the new Chancellor said: “I’m just as concerned about the cost of business as I am about the cost of living. Tax, energy, supply-chain costs, labour – I know that businesses large and small have felt really squeezed.” If action can match rhetoric in the upcoming budget, it may be that businesses can finally have some much-needed stability.
Reasons for optimism
Carl Stick, co-manager of Rathbone Income, has a more optimistic take on the outlook for the UK. “There are grounds to believe the market can keep climbing this wall of worry, but the UK economy continues to edge forward. With oil prices back to near pre-conflict levels, inflationary pressures seem to be easing, though this is no time for complacency. Employment data, too, have held up better than many feared.”
Perhaps most importantly, the UK market still looks cheap, unlike – say – the US market where high valuations offer little or no buffer against rising inflationary pressures or an economic slowdown. This is particularly true for small and mid-cap companies. The yield on the FTSE 250 is now 3.2% and 3.8% for the FTSE Small Cap index****. Investors are paid to wait.
Carl Stick says: “The UK market still offers good value and, in our view, could provide relative shelter if global markets stumble. This year’s pick-up in bid activity shows that this value is being recognised. The ride is unlikely to become any smoother, but the direction of travel remains encouraging.”
UK financial markets have grown used to churn. Radical economic policy does not appear to be on Andy Burnham’s agenda, and, against that backdrop, they can continue to muddle along. Expectations are low and no incoming Prime Minister can change the uncomfortable realities of the UK economy. The only trick that Burnham could pull off is a vibe shift, reviving confidence in the UK economy and getting people spending again.
