UK small and mid-cap companies are set to benefit from falling household debt and rising wage growth, according to CT Global Managed Portfolio trust manager Peter Hewitt, despite concerns about government spending and stubbornly high interest rates.
Government debt has risen to all-time highs during the past decade, but the opposite can be said for the average UK consumer. Household debt peaked at 156.4% of disposable income in 2008 and has been in steady decline ever since, dropping to 121.3% by the second quarter of this year. It was a notable burden on growth at the time, with household debt representing 95.4% of gross domestic product in 2008, but this figure had fallen to 78.8% by the start of 2024.
The debt crisis following the global financial crash in 2008 was a clear catalyst for this decline. Consumers naturally became more cautious, according to Hewitt, yet the scrapping of interest rates had a far bigger impact on their relationship with borrowing. Without interest rates, consumers could continue to take on debt – perhaps even more than before the credit crunch – but could pay it off easier.
Hewitt says: “The financial crash had many long-term repercussions. People were unwilling to take on new debt and keen to pay down existing debt. But it is important to remember that interest rates went to virtually nothing. People found paying off debt wasn’t as expensive as it once was. So while government debt has exploded on the upside, household debt has gone the other way, and I think this will continue now interest rates are higher again.”
Return of the rates
After more than a decade of zero interest rates, central banks around the world – including the Bank of England – set new highs in 2021. And while rates have lowered slightly this year, economists anticipate a tighter monetary environment for years to come. That means new debt will be a lot harder to pay off, so will we see household debt bounce back?
Apparently not, according to Hewitt, who believes UK consumers will be averse to taking on new debt if it is more expensive to pay off. And this won’t come at the expense of consumer spending, with UK households sitting on double the amount of savings they held before Covid – they had £143bn squirreled away before the pandemic, but that has rocketed to £338bn today, Hewitt adds. Thanks to these higher savings and lower debt, consumer spending has been steady.
Income on the rise
Another factor driving the lowering of household debt has been wage growth, notes Hewitt. People in the UK have increased the volume of borrowing since 2008, but it is a smaller proportion of household income as salaries have risen. Average weekly earnings are up 46.7% over the past 10 years, to £646, according to the Office for National Statistics, making paying off debt less of a burden.
And recent moves by chancellor Rachel Reeves to increase the national minimum wage to £12.21 an hour could further boost household income, says Hewitt. Though he notes other decisions in Reeves’ first budget could hinder growth, namely the £20bn employers will be spending on National Insurance“It may not be quite as bad for companies if the top line grows,” he explains. “Consumers’ savings are still full, their wages are rising and debt is down – in other words, there is plenty of money to spend.”
Despite this favourable backdrop, UK consumers have been reluctant to spend in any meaningful way. Though it remains elusive as to what will trigger UK consumers to splash out, Hewitt says “all the fundamentals are pointing the right way”.
This point is echoed by Cassie Herlihy, associate director for public equity at Gresham House: “We like businesses with strong balance sheets because they can withstand shocks –and that same principle works for the consumer.”
These strong foundations have led Hewitt and Herlihy to favour small and mid-cap companies, which are primed to benefit from this due to their high exposure to the domestic UK market.
This article first appeared in the December issue of Portfolio Adviser magazine