Editors’ Note: MarketMinder Europe favours no politician nor any political party, and our commentary is intentionally non-partisan. We assess political developments for their potential economic and market impact only.
We think one of the financial world’s stranger quirks is its tendency to name its very, very bad days. 1929’s stock market crash was “Black Tuesday”.[i] 1987’s was “Black Monday”.[ii] When the British pound crashed in 1992 as the country left the European Exchange Rate Mechanism, it was “Black Wednesday”.[iii] So you might think that, given financial commentators we follow have already named 3 February 2022 “Black Thursday”, UK stocks or the pound crashed.[iv] Yet Thursday, British stocks ticked down just -0.6% in sterling—hardly a move worth naming.[v] The pound strengthened slightly against the dollar.[vi] No, Thursday earned its auspicious moniker not because of market reaction, but because of energy regulator Ofgem’s announcement that the energy price cap will rise 54% in April, the Bank of England’s (BoE’s) 0.25 percentage-point (ppt) rate hike, and the monetary policy institution’s forecast for the inflation rate to top 7% this spring.[vii] Based on all the data available right now, this, plus forthcoming tax increases, looks set to take a bite out of households’ real disposable incomes this year. In our view, this likely creates political problems for embattled Prime Minister Boris Johnson and his potential rival, Chancellor of the Exchequer Rishi Sunak—and leads to what we think are some rather strange policy responses. Let us parse the day’s events and explore the potential market implications.
Our view on Thursday’s rate move as a macroeconomic and stock market risk hasn’t changed since last Tuesday’s commentary. We think markets have largely factored the widely expected move into share prices already. Furthermore, the UK’s yield curve—a graphical representation of one issuer’s interest rates across a range of maturities, from short to long—doesn’t appear to be at risk of imminently inverting.[viii] That is a plus, as many economic researchers we follow argue inverted yield curves—when short rates top long—often precede recessions. But we think rate hikes do have some secondary effects, and those could add to some households’ woes.
Chiefly, about one-fourth of home mortgages in the UK have variable interest rates, which tend to rise and fall in sympathy with the Bank Rate.[ix] A 0.25 ppt rate hike probably won’t break the bank for many of these homeowners, if you will pardon the pun, but it will divert some extra cash to mortgage payments. This, at a time when homes on household energy providers’ default contracts will see the price cap for their annual bills rise by £693 to £1,971—and if you know anything about price caps, you know the cap tends to be more target than ceiling.[x] Compounding matters, the National Insurance Contribution rises in April, which BBC News estimates will cost each worker several hundred pounds annually.[xi]
Then, too, prices are rising generally, with inflation outside energy running just over 4% y/y.[xii] Wage growth, according to the latest BoE forecasts, likely won’t be enough to offset all the added expenses.[xiii] We point this out not to spread gloom, but because we think it is important to look facts head on and acknowledge when all isn’t grand.
The government is also acknowledging this and, as governments are wont to do, is trying to help. No, it isn’t abolishing the energy price cap, which we continue to think hasn’t been a net benefit and likely makes prices higher than they would otherwise be, as it has driven suppliers out of business and killed competition.[xiv] Instead, Sunak announced twin handouts: A £150 council tax credit for households in bands A through D and a £200 energy bill discount.[xv] Yet people won’t receive the latter until October, and households will have to pay it back over the next five years. Essentially, it seems Sunak is betting that the energy price cap will fall a year from now so that households won’t notice a £40 annual rebate repayment charge. That is … not a sure thing, in our view. Needless to say, Sunak’s plans landed with a giant thud.[xvi]
We see two general implications here—one economic and one political. On the economic front, we think it is fair to say UK consumer spending is probably not on the verge of a boom. Not with real disposable income (meaning, after-tax income adjusted for inflation) poised to weaken and rising energy bills likely to sap demand for more discretionary purchases.[xvii] We don’t think an outright economic contraction is likely, as higher energy bills still add to Gross Domestic Product (GDP, a government-produced measure of economic output).[xviii] But these rising costs likely create winners and losers, and it would surprise us if spending on goods and fun services in general were to drag a bit. The BoE already projects slower GDP growth this year, with its 2022 forecast down from 5% in November to 3.75% now.[xix]
We think reality may be weaker still. We don’t think this makes a bear market (a prolonged, fundamentally driven broad equity market decline of -20% or worse) likely to arrive in the near future, but we do think this points to growth-orientated stocks likely beating value-orientated stocks. Growth-orientated stocks generally have higher valuation metrics like price-to-earnings ratios and focus on reinvesting profits into the core business to expand over time, making their profits relatively less sensitive to economic ups and downs. As a result, they typically do better in slower-growth environments.[xx] Value-orientated stocks, by contrast, tend to carry relatively lower price-to-earnings ratios and more debt, making them more sensitive to economic conditions. That said, as UK stocks tend to be more value-orientated due to their heavy Energy, Materials and Financials weightings, we think they will likely lag the world.[xxi]
On the political front, all reports indicate Johnson is in trouble. The official report on the Partygate scandal, which came out last week, did not paint 10 Downing Street in a favourable light.[xxii] Several high-ranking aides have since quit in apparent protest of Johnson’s actions, and more Conservative backbench Members of Parliament appear to be sharpening their knives. [xxiii] We think Thursday’s cost of living body slam likely makes things worse. Johnson’s attempts to pivot with industrial and climate plans aren’t winning over the masses, either.[xxiv] Meanwhile, Sunak—often named as a top contender in a potential leadership challenge—is seeing his own stock fall with household expenses and taxes going up, and Thursday’s attempt to help people doesn’t appear to be helping matters.[xxv] There are other potential challengers in the wings, including Foreign Secretary Liz Truss, but it isn’t clear the party overall has much appetite for a leadership change. Labour remains ahead in the polls, and whilst the next general election isn’t due until 2024, senior cabinet members have warned a successful leadership challenge would require a snap election so that the new prime minister could get a mandate from voters.[xxvi] After all, many commentators we follow pinpoint Gordon Brown’s decision not to do so in 2007 after taking the reins from Tony Blair as the start of his downfall with voters.[xxvii] With little indication that the Tories would be able to win a general election right now, given none of the leadership contenders have personal popularity on par with Johnson’s in 2019, we think the status quo could very well stick.
The upshot in that scenario would likely be a very gridlocked government, in our view. That will perhaps annoy those who were hoping for a big post-Brexit deregulatory push, but it will also prevent radical legislation in general, which our research finds is typically a tailwind for stocks. A government that can’t pass much can’t create many winners and losers, which we think reduces uncertainty. Whilst the UK’s value bent and likely slow economic growth will probably keep it from leading, the current political uncertainty dissolving into gridlock over the next few months appears likely to at least keep British markets climbing, in our view.
As for the other possibilities? We think a successful leadership challenge without a snap election would probably also yield gridlock, as the party likely wouldn’t want to rock the boat ahead of 2024’s contest. And if there is a snap vote, well, we think it is best to cross that bridge if and when it arrives when considering politics’ market impact. Simply having a contest would raise short-term uncertainty, in our view, but we think the longer-term impact would depend on how strong a mandate the winner secures, how campaign proposals have affected sentiment and how reality looks poised to square with expectations. For now, we think it is far, far too early to sketch all of this out. So, we advise patience—but we will be watching closely for you.
[i] “Oct 29, 1929 CE: Black Tuesday,” Staff, National Geographic, 11/3/2021.
[ii] “Black Monday,” Adam Hayes, Investopedia, 31/10/2021.
[iii] “Black Wednesday,” Will Kenton, Investopedia, 8/3/2020.
[iv] “’Meltdown in Downing Street’: Front Pages Batter Johnson After ‘Black Thursday,’ Martin Farrer, The Guardian, 4/2/2022.
[v] Source: FactSet, as of 3/2/2022. MSCI UK Index price return on 3/2/2022.
[vi] Source: FactSet, as of 3/2/2022.
[vii] “Price Cap to Increase by £693 From April,” Ofgem, 2/2/2022 and “Monetary Policy Report – February 2022,” Bank of England, 3/2/2022.
[viii] Source: FactSet, as of 4/2/2022. Statement based on benchmark 3-month and 10-yaer government interest rates in the UK.
[ix] Source: UKFinance.org.
[x] See Note vii.
[xi] “National Insurance: Opposition MPs Urge Rethink on April Tax Rise,” Staff, BBC News, 30/1/2022.
[xii] Source: FactSet, as of 3/2/2022.
[xiii] See Note vii.
[xiv] Both main parties shoulder some blame for this, as it was a Labour proposal that a Conservative government seeking a polling boost adopted.
[xv] “Millions to Receive £350 Boost to Help With Rising Energy Costs,” HM Treasury, 3/2/2022.
[xvi] Sunak’s Energy Rebates Won’t Even Come Close to Helping People With Soaring Bills,” Polly Toynbee, The Guardian, 3/2/2022.
[xvii] See Note vii.
[xviii] Spending on utility bills is still consumption of services. It isn’t consumption of enjoyable services, but it is consumption nonetheless.
[xix] “Monetary Policy Report – November 2021,” Bank of England, 2/11/2021.
[xx] Source: FactSet, as of 4/2/2022. Statement based on MSCI World Growth and Value Index returns with net dividends.
[xxi] Source, FactSet, as of 7/2/2022. Statement based on MSCI UK IMI market capitalisation. Market capitalisation is the measure of a firm’s size calculated by multiplying its share price by the number of shares outstanding.
[xxii] “Sue Gray’s Initial Findings on Parties Published,” BBC News, 31/1/2022.
[xxiii] “UK’s Boris Johnson Loses 4 Senior Aides Amid Partygate Scandal,” Staff, Fox News, 3/2/2022.
[xxiv] “What Levelling Up? Councils Forced Into Tax Rises and Drastic Service Cuts,” Chaminda Jayanetti, The Guardian, 6/2/2022.
[xxv] See Note xvi.
[xxvi] Source: Politico, 4/2/2022.
[xxvii] “What If Gordon Brown Had Called an Election in 2007?” Steven Fielding, University of Nottingham, 17/1/2012.
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