I’ll happily admit I am one of the many that did not know what proroguing was until Prime Minister Boris Johnson declared he had asked the Queen to suspend parliament until 14 October.
A quick google search found that John Major was the last PM to ‘prorogue’ in 1997, in a bid to avoid parliamentary debate of the Parliamentary Commissioner’s report on the cash-for-questions affair. I was too busy watching Ruud Gullit’s Chelsea back then!
What we have now, in a nutshell, is politics chaos. Despite royal approval being given to legislation requiring a delay to Brexit beyond 31 October – unless a deal is approved or parliament agrees to leave the EU without one by 19 October – Johnson has insisted he will not ask for another extension. He has also failed in his attempt to force an early general election. This was the sixth parliamentary defeat for the PM in a week.
While the PM may not want a Brexit delay, talk of one until 31 January 2020 is the last thing the UK economy needs, as the Brexit discount continues to effect sterling and company valuations.
From a stock market perspective, the UK remains fairly resilient, with the FTSE All-Share returning 11.94%* year-to-date – although this still lags behind other markets with the MSCI AC World rising 19.78%* over the same period.
But a recent note I read from Artemis Income manager Adrian Frost summed up the scenario well by stating “all the possible pathways for the UK remain as overgrown and indistinct as ever. This is enough to keep investors on the sidelines.” It’s done more than that. Retail investors have pulled almost £2bn** net from UK equity funds in June and July 2019 alone. The number totals almost £4bn** in the past 12 months.
M&A activity may start to ramp up
With the pound now at 1.23 to the US dollar (it was 1.63 five years ago)*** UK plc is not just unloved, it is looking cheap. I recently spoke with Crux UK Special Situations fund manager Richard Penny, who believes this is one of maybe four or five reasons why M&A activity is bound to pick up.
We’ve already seen some activity, such as the £4.8bn takeover of Merlin Entertainments, which owns the likes of Alton Towers and Legoland. Pub giant and brewer Greene King has agreed to be bought by Hong Kong operator CKA, while US private equity firm Advent International is set to purchase UK aerospace and defence supplier Cobham. Richard believes these deals are likely to have begun around two or three months ago when the pound was closer to 1.30. Does that mean more bargains are on the way?
If we we’re to crash out of the EU with no-deal I would concur with Penny that the pound would fall further and 1.05/1.10 to the dollar would not be unheard of. At that level Britain would be up for sale as it would be an opportunity for foreign businesses looking over a 10-year timescale. We have not even touched upon the fact UK analysts believe the market is already being undervalued to the tune of 20-25%.
The late cycle scenario we are in also improves the chances of M&A, as company management look to make up for slower growth by acquiring businesses and cutting costs. Cheap debt will also continue to entice corporates and private equity buyers.
Clarity either way brings opportunities
I’ve said before that a no-deal Brexit is likely to result in a recession in the UK – but that would at least, I suppose, bring opportunities. Some funds investing in larger, dollar-earning companies and those investing in more resilient businesses are likely to do better in the short-term – companies like those held in TB Evenlode Income or Liontrust Special Situations. Over the longer term, plenty of bargains could be found by value managers like Investec UK Special Situations manager Alastair Mundy or Thomas Moore, manager of ASI UK Income Unconstrained Equity.
If we do get a deal – we might expect UK equities to go up. In this case, most UK equity funds would do well, but perhaps UK smaller companies funds – or those with a bias to small-caps like Crux UK Special Situations – even more so.
If, however, we end up kicking the can down the road even longer, UK plc will remain in its state of limbo – not reinvesting and not making progress. A recession may occur anyway and even foreign buyers might wonder if a cheap price tag is still too much too pay in a rudderless environment.
*FE Analytics, total returns in sterling, 1 January 019 to 9 September 2019.
**Combined losses for Investment Association UK All Companies, UK Equity Income and UK Smaller Companies (net) in both timeframes
***Figures as at 10 September 2019
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
