Does A New Prime Minister Change Anything For UK Assets?

Does A New Prime Minister Change Anything For UK Assets?
Stéphane Renevier, CFA

over 1 year ago5 mins

  • Investors see Britain’s new prime minister as a step in the right direction, likely to bring market stability, renewed credibility, and policies that could reduce the risk of a deep and prolonged recession.

  • But the UK economy is still facing an uphill battle and its political risks remain high.

  • While UK assets might have further to fall in the near term, they are now at attractive levels for long-term investors.

Investors see Britain’s new prime minister as a step in the right direction, likely to bring market stability, renewed credibility, and policies that could reduce the risk of a deep and prolonged recession.

But the UK economy is still facing an uphill battle and its political risks remain high.

While UK assets might have further to fall in the near term, they are now at attractive levels for long-term investors.

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The UK’s government bonds and its currency were a hot mess for much of the extremely short tenure of former Prime Minister Liz Truss. And that was mostly because of an ill-conceived and controversial package of tax cuts and other measures her administration authored during the few short weeks she was in office. Now, she’s gone and the man who warned us about the whole ensuing market mayhem is now in charge. But has anything actually changed for the UK’s assets and its economy?

Yes: there’s a new sense of stability.

Truss threw the UK’s assets into chaos with a badly received plan for tens of billions in bond-funded tax cuts that risked adding more heat to the UK’s already smoldering inflation fire and threatened to overload the country’s debt burden. Her successor, Rishi Sunak, is not expected to take anything like the same approach, (though we’ll have to wait until November 17th to find out what his plan is). He’s widely perceived as market-savvy, competent, and pragmatic. He’s a former chancellor of the exchequer, after all, with an MBA, a stint at Goldman Sachs, and a reputation for fiscal restraint. The latter is particularly important: with the government’s credibility seen as at least partially restored and with inflation less likely to run even hotter, the additional risk-premium that investors required to hold UK assets under Truss has been greatly reduced.

Yes: the recession is likely to be shallower (and might come sooner).

Under Sunak, the policies of the government (fiscal policy) and that of the independent Bank of England (monetary policy) are likely to be more closely aligned, with both prioritizing the need to tame inflation. With both entities rowing in the same direction, the BoE is likely to face fewer pressures to hike rates aggressively. This is already being “priced in” by the market, with interest rates now expected to peak at 5%, compared to 6.3% a month ago when Truss’ tax plan was released. Since aggressive rate hikes were the biggest threat for a deep and prolonged recession, a softer path ahead makes a shallower recession more likely. That being said, it might come sooner: Sunak might want to get the worst over as quickly as possible (blaming Truss’ policies in the process) so that he can engineer a recovery and build political capital ahead of a potential election.

No: the UK economy still faces an uphill battle.

Even if the old UK ship seems to have a much more capable captain at the helm, it’s still damaged and sailing in the same stormy waters. Brits are facing the biggest cost-of-living crisis in generations, consumer confidence is at a record low, inflation is at a record high, and economic indicators show that if the country isn’t already in a recession, it’s rapidly heading into one. And things don’t look much rosier over the longer term: the UK is facing a rising budget and current account twin deficit, stubbornly low productivity growth, a declining labor force, and weak capital investments.

What’s worse, there’s little the new government can do about it in the near term. As Truss painfully realized, investors have very little tolerance for pro-growth policies when inflation’s running this hot. The economy might need pro-growth policies, but with inflation this high, those will only create more problems. The best the government can do is try to limit the damage to growth.

No: political risk is still high.

Despite his warm welcome in the markets, Sunak is hardly being hailed as a man of the people. And he might never be. Sunak made a fortune working in high finance, so some people view him as an out-of-touch elitist – and that’s a challenge when you’re tasked with leading a country that’s mired in one of its biggest-ever cost-of-living crises. And, since he wasn’t challenged for the PM job, he won it without the usual party vote, denting his legitimacy. On top of having to make some politically unpopular decisions, he might also be forced to call a general election sooner than some expect (he can legally wait until January 2025) if he wants to establish some authority. In short: you shouldn’t count on political risk to go away just yet.

What’s the opportunity then?

Let’s face it, the UK economy is likely to get worse before it gets better, and its assets aren’t out of the woods yet. And while Sunak’s leadership may be a step in the right direction, no one can immediately transform an old cruise ship into a speedboat. That being said, a more fiscally responsible new government does reduce the risk of disaster at sea. And that makes UK assets investable again.

And while things are bad, they may be getting better. The outlook for the UK pound isn’t just one-sided anymore, and buyers have emerged at these levels. The same can be said for British government bonds, or gilts. As for UK stocks, they may not be the opportunity of a lifetime, but with the FTSE 100 at a low 8.5x forward price-to-earnings multiple – a level not seen since the global financial crisis of 2008 – it’d be hard to argue that they aren’t worth a look at these levels.

Now, of course, valuations may not be the best predictor of returns in the short term – they can always get cheaper and prices could come down for a lot of other reasons. So if you’re thinking of buying UK assets with the hope of making a quick profit, beware. But if you’ve got a long-term horizon – say 10-plus years – current valuations suggest you’ve got a decent margin of safety and could generate attractive returns over that period. Consider using dollar-cost averaging to build your position, with the potential to add more stocks to your portfolio if prices fall further.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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