Constituent policy

Investors retreat in the face of the British “political vacuum”

High inflation, slowing economic growth and a long summer of political wrangling are making it hard for global investors to like battered British assets.

UK government bonds and the pound came under pressure, dropping worries about how inflation might spike. Goldman Sachs has predicted inflation could top 20% next year if energy prices stay high, making the UK ground zero for stagflation – the ugly mix of high inflation and a economic stagnation.

Some of the strong brakes on UK markets are global. But for many investors, a lack of clarity on government spending and tax plans in the face of a worsening cost-of-living crisis has exacerbated the problem. Prime Minister Boris Johnson resigned in early July, but his successor is not expected to be announced until Monday. Details on how the government could help ease the pressure on businesses and households will come later.

“The fiscal policy vacuum creates a lot of uncertainty about the UK, which doesn’t exist quite the same elsewhere,” said Oliver Blackbourn, fund manager at the multi-team. assets of Janus Henderson Investors.

“It looks like the UK is the worst in terms of stagflation sweeping across developed markets,” he added. This “makes it very difficult for investors to understand and value UK assets”.

Yields on 10-year gilts have risen from 1.8% to 2.9% since the start of last month as prices fell, while the pound fell more than 5% against the dollar, the two marking faster declines for the UK than for other developed economies.

“The pound has had a pretty torrid time,” said Francesca Fornasari, head of FX solutions at Insight Investment, which is betting the pound will fall against the dollar. “There is an unnecessary combination of dynamics, which means the UK. . . has an additional set of risks associated with it.

She recently turned even more bearish on the pound, citing “the leadership race and discussions over fiscal policy and relations with [the] EU”.

In government bonds, the value of short bets against interest-rate-sensitive two-year debt has risen 79% this year, according to S&P Global Market Intelligence.

Janus Henderson’s Blackbourn sold gilts in some portfolios ahead of the last Bank of England meeting, preferring bonds from other countries where inflation is expected to peak sooner. “It may not be the best prospect [for] the gilt market, certainly in the short term,” he said.

Some managers also bet against longer-dated bonds. Crispin Odey, founder of Odey Asset Management, whose European fund is up around 120% this year, has been shorting bonds, including the 30-year gilt, and believes inflation will remain elevated for ” at least several years”.

Mark Dowding, chief investment officer at BlueBay Asset Management, is also shorting gilts and betting that long-term yields will rise relative to short-term ones because, he says, US inflation has peaked and inflation of the euro zone will have done so by the end of the year, while British inflation will continue to rise.

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UK large cap stocks are something of an outlier. The FTSE 100 is one of the best performing national equity indices in the developed world this year, down just 1.4% in sterling terms, while the US S&P 500 is down 17% and some European indices have fallen by almost a fifth. .

But the bulk of FTSE 100 companies earn revenue in dollars and other currencies that have gained against the pound, flattering their bottom line. The index is also full of energy companies that have done well during this year’s commodity boom.

Additionally, investors seem less inclined to make overtly negative bets against UK equities than against gilts or sterling. Many are aware that the UK market’s preference for cheap so-called ‘value’ stocks in sectors such as mining and energy, which generally fare better than high-growth stocks during periods of high inflation. , could mean that UK equities continue to outperform other equity markets. .

According to data group Breakout Point, there has been a decline in short-selling activity of UK stocks by hedge funds in recent years. The funds have increased their disclosed short bets around 1,800 times last year and 2,200 times so far this year, compared to around 6,700 times in 2018.

“I wouldn’t say that in the UK customers are outright bearish,” said Paul Leech, co-head of global equities at Barclays. “What we have seen is a denouement of risk.” He said investor sentiment towards the UK and the rest of Europe is similar, with many investors preferring US equities instead.

“There is a lot of bad news out there. But a lot is embedded” in UK stocks, he added. This reassures more optimistic investors about the UK’s outlook.

Line chart of % change year to date showing UK stocks outperforming Wall Street

Peter Davies and Jonathon Regis of hedge fund firm Lansdowne Partners recently wrote, in a letter to investors seen by the Financial Times, that their “conviction that there are few sellers left in the UK has probably grown stronger “.

They added: “We continue to believe that any period of relative calm will quickly see UK assets revalue in a way that can easily be self-reinforcing.” Lansdowne’s Developed Markets fund holds almost half of its assets in the UK, compared to a third in Europe and 15% in the US, according to the letter.

With a large proportion of its constituents in areas such as oil and mining, some managers such as Richard Buxton of Jupiter Asset Management believe the UK stock market appears well-adjusted to current economic and market conditions.

“As a place to slowly lose money – which is all you can do in a bear market – I think the UK is great,” Buxton said, adding that the target was to have “enough money to do massive business at the end”.

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