The Dash for Growth
Henry Cobbe CFA, Head of Research at Elston Consulting, discusses the potential effect of the mini-budget on UK equities.
The mini-budget's ‘fiscal event’ heralded the arrival of ‘Trussonomics’. As set out in their 2012 manifesto, Britannia Unchained, Truss and Kwarteng set out the case for prioritising growth over debt reduction. Whilst an exciting prospect in times of plenty, in the context of monetary tightening, rising rates and soaring inflation, this seems to be too much, too late. The mini-budget triggered a maxi-shock on gilts and sterling, as the government rolled the dice with UK financial credibility.
By not publishing the supporting figures as to whether and how they can balance the books following this unfunded tax cut, the market is left to judge if their plan is viable. The surge in gilt yields and nosedive of Sterling suggests this policy brings more risk than reward.
How does this affect UK equities?
Whilst the ‘dash for growth’ is positive for some UK companies from a tax perspective, it will favour exporters (stronger dollar, cheaper manufacturing costs), and penalise those that rely heavily on imported goods. From a UK equity market segment perspective, we look at the following key exposures:
- UK Large Caps: UK large caps have a high proportion of overseas earnings so funds benchmarked to the FTSE 100 such as HSBC FTSE 100 UCITS ETF (LON: HUKX) relatively strengthen when Sterling weakens.
- UK Mid Caps: UK mid-cap companies better reflect the domestic market. If the fiscal stimulus does indeed translate to higher economic growth rate, then mid-caps have potential to benefit. Examples of mid-cap exposure include Vanguard FTSE 250 UCITS ETF (LON:VMID)
- UK Small Cap: Ironically, the dash for growth may not help ‘Growth-style’ companies in the near term. Whilst UK small caps are domestically-oriented, their growth-factor bias means they are ‘longer duration’. This means they are more sensitive to rising discount rates (inflation and interest rates), by which future earnings are valued. Small cap exposure can be accessed using iShares MSCI UK Small Cap UCITS ETF (LON:CUKS)
- UK Equity Income: UK equities that are income-generative tend to exhibit biases to both Yield- and Value-factors and are typically more resilient when the going gets tough. SPDR S&P UK Dividend Aristocrats UCITS ETF (LON:UKDV) automatically includes companies that have persistently paid a rising dividend over the last seven years
Managers and investors have the ability to target specific exposures within the broader UK equity space, depending on their view. Markets are still digesting the impact from this fiscal restructuring. Looking back in five years, we can judge if this was a bold stroke of genius, or a reckless policy error. The initial indicators suggest the latter.
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