I think we can begin to see the outlines emerging of how the new prime minister may be able to engineer a miraculous escape from electoral oblivion, one which could point to a sudden and strong revival in prospects for UK equities.
First the political assumptions.
My sense is that a renegotiation with the EU on the withdrawal agreement will be as successful as that chat with Labour a few months ago i.e dismal failure. The PM has been as clear as possible that we are leaving on October 31st deal or no deal. For me that means no deal although I suppose it is just about possible that we can see a slightly reshaped May Withdrawal agreement refloated.
Assuming that the PM doesn’t call a general election before October 31st – a big assumption I grant you – we will be out of the EU on November 1st. For BJ that will be first, biggest mission accomplished. The Brexit Party would have been effectively spiked.
I would then go for an almost immediate general election and also in parallel announce a major reversal of austerity and extensive fiscal expansion. More on that below.
Thus, an election in say late November or early December could be fought on delivering Brexit and boosting the UK economy. That would probably reunite the Brexit and Conservative vote but still leave the opposition – the Lib Dems with a shiny, young new leader and Labour with a less than shiny old bloke – hopelessly divided. Sure, the Conservatives would lose some Southern seats to the LDs but they might do well in many other Midlands and Northern seats. Labour would also be ambushed in Scotland again, losing their seats.
In this possible scenario, Boris might actually pull off what former PM May had hoped for in 2017. A convincing majority win with the opposition vote badly divided. Once safely ensconced in power BJ might then lean more aggressively towards his One Nation tendencies and really loosen the purse strings. Obviously, there are a whole number of factors that could go wrong in my scenario, not least that he doesn’t get No Deal through or he loses said election, but on balance I think the more probable scenario is the way I have traced out. The key, to repeat the point, is to deliver an exit on Oct 31st no matter what to remove the national uncertainty (and bugger the consequences of a No Deal hit).
From an investor point of view, the key factor here is that uncertainty. Get out of the EU on Oct 31st, call a snap election and reboot the economy and you have a decisive end to the era of uncertainty. In this scenario, we could see an aggressive bounce in UK focused equities as domestic businesses make up for lost time.
That would also serve to accentuate what has also been apparent – that UK equities have underperformed and are good value in relative terms. I was struck by a recent note from wealth firm Killik which called a possible buy-in UK equities. Four charts from their pack stood out.
The first two are below and remind us that the FTSE All in GBP terms has underperformed the All World by around 20%. UK Small Caps and Mid Caps have shouldered the bulk of that underperformance while the FTSE 100 looks less compelling value.
The next two charts, also from Killk suggest that this underperformance has resulted on a relatively low valuation with the FTSE All currently running at a discount of around 20% compared to the FTSE All World.
The reasons for this underperformance are varied. UK equities are almost certainly under-owned at the global level but investors have also been spooked by macroeconomic factors. I would also suggest that the Bank of England has also been rather too eager to tighten the screws whilst keeping interest rates low.
The next chart below is from research firm Cross Border and shows how overall UK liquidity (they measure both private sector and central bank forms) has collapsed over the last year. That has coincided with a rapid decline in one key UK macro metric – UK CBI numbers. These numbers are currently signalling a sharp recession. My own reading is that the evident fog of uncertainty has led to a sharp decline in new orders.
Cross Border Capital have tried to isolate the various inputs into their liquidity model, to see if Brexit has been the primary factor. They hunch is that although private sector liquidity has tightened since Brexit, the key driver has been central bank policy decisions i.e the Bank of England has been too hawkish.
In the blame game I’m not too sure any one factor is a winner but what is obvious is that we cannot carry on with a) more political uncertainty over Brexit and b) central bank tightening. Both drivers have to change. BJ will deliver Brexit – for right or wrong – while the BoE will be forced to unwind monetary tightening.
Thus, we have the ground set for a post Brexit bounce, with UK fiscal easing on a substantial scale plus an easing of monetary policy. In this scenario we could see a very strong bounce both in UK mid and small caps as well as the pound.
Here’s Cross Border’s own take on what might happen next : they think that the next step needs to be
“a looser monetary stance to be matched by a proportionate boost to fiscal policy. A more accommodative fiscal policy would itself improve private sector cash flows and so help satisfy the above condition that Central Bank and private sector liquidity should move together for sterling’s sake. What’s more, if the monetary boost takes the form of a renewed QE programme, this may provide the means to finance more infrastructure and even tax giveaways. Prime Minister Boris would be stealing the opposition parties’ much-mooted policy of a ‘People’s QE’. At a stroke, the in-coming Government could deliver a significant net stimulus and without risking further sterling weakness. So, could a ‘Boris Boom’ involve a move from QE3 to HS31 perhaps?”