Market Views: How should Asian investors approach UK markets after the political turmoil?
On October 25, Liz Truss stepped down as British prime minister after just 50 days in office, during which big tax cuts in a hastily-assembled mini-budget prompted financial turmoil.
Her departure ended a turbulent and at times chaotic premiership, marked in its final days by a series of policy reversals. Her initial pick as chancellor, close ally Kwasi Kwarteng, delivered a mini-budget only weeks after taking office in which he announced the biggest package of tax cuts in 50 years.
The plans, which had not been assessed by the government's fiscal watchdog, spooked investors and led to a steep rise in the cost of UK government debt.
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Truss, who had argued during her Tory leadership bid that the UK tax burden had held back economic growth, at first defended her approach but later fired Kwarteng. His replacement as chancellor, Jeremy Hunt, then abandoned almost all of the tax cuts in a bid to stabilise the financial markets.
The move was welcomed by investors but badly undermined Truss's political credibility, and she faced calls to quit from her own MPs. Her successor Rishi Sunak, the UK's third leader in less than two months, now faces the task of steering the UK through a period of economic crisis marked by low growth and high inflation.
Against this backdrop, we asked asset managers how Asian investors with allocation plans to the UK should react to the new political leadership and the state of British economy and financial markets, and what new opportunities the recent developments have unearthed in the UK.
The following contributions have been edited for clarity and brevity.
James Athey, investment director, rate management
The fundamental situation is that sterling hovers near multi-decade lows versus the US dollar and the benchmark UK FTSE 100 trades at an historically attractive price earnings multiple of around nine based on year-end earnings expectations. While there has been some short-term damage to the credibility of UK policy-making the secular reality is that the UK’s institutions and institutional credibility remain strong, as does its envy-of-the-world rule of law.
We most assuredly do not believe that the recent political and financial market turmoil has done lasting damage to the UK’s attraction as a global investment destination. The near-term path for the UK economy is fraught with danger but the new government team quite obviously recognises these dangers in a manner which more reasonably matches those of financial market participants. We do not expect a return to the volatility of late September, and we do ultimately expect inflation to fall significantly in 2023, as a result we think the UK already reflects an attractive long-term investment destination, albeit one which may become more attractive in the immediate future as policy-makers wrestle with the vexatious growth/inflation trade-off.
Peter Young, CEO and co-founder
Q Investment Partners
For Asian investors looking at the UK right now, they might be startled by the messy politics, looming recessionary risks and a slipping pound. This narrative is widely accepted and even spurred onwards by the doom-and-gloom headlines we read every day in the UK, Singapore, Hong Kong and wider Asia. However, looking beyond the headlines, we feel that the fundamental drivers behind the UK remain strong, having not changed overnight simply because of political instability and a turbulent economy.
These headwinds may even present some semblance of opportunity for those looking to invest – with a weaker pound, suddenly investments in the UK become a lot more affordable. From a real-estate lens, currently, we see lots of good asset purchasing opportunities; sturdy fundamentals, including an ongoing demand-supply imbalance, combined with prices that are driven down by high rates and the maelstrom of negative narratives. When you add comparative SGD or USD purchasing power to the mix, we see a market full of opportunity for Asian investors.
In terms of possible risks, we turn to the historic strength of the UK brand for comfort – think UK higher education institutions like Oxford and Cambridge, Rolls Royce and Wimbledon. All are institutions that have withstood previous periods of difficulty and remain synonymous with our confidence in the UK’s ability to weather short-term uncertainty.
Florian Ielpo, head of macro, multi-asset
Lombard Odier Investment Managers
The change in leadership at the head of the country should bring about a much better understanding between the government and the Bank of England, and that is fundamentally good news. Both sides (government and central bank) have learned their lessons now: unfunded fiscal packages lead to unsustainable jumps in rates; a too aggressively hawkish monetary policy can be a threat to financial stability, leading to a loss in credibility.
From both these perspectives, UK bonds and equities must look now a lot more appealing to Asian investors, but we think a difference must be made between both. Our macro metrics show how “geographic” Europe, inclusive of the UK, is now getting increasingly close to a recession. From that perspective, hedged UK government bonds look increasingly appealing for both their carry and diversification potential: rates decline during recessions. The same is not true in the case of equities: often unhedged in large investors’ portfolios, they have a tendency to underperform when entering into a recession both because of the declining equities and of the decline in the Sterling’s value. Time to reconsider UK bonds – not so much UK equities.
Matthew Holdgate, portfolio manager and senior analyst, global fixed income
Nikko Asset Management
Notwithstanding the recent recovery, it is our view that UK financial assets continue to embed an unjustified risk premium. Even following recent declines, short term interest rates are still pricing a peak policy rate close to 5%. We believe this is unlikely to be realised given the extent of the slowdown in the UK economy. Persistently high prices have eroded a significant share of household savings accumulated during the pandemic. The current path of interest rate hikes would also result in a sizeable increase in average payments for the circa 40% share of mortgages due to repricing in 2023, a scenario that the Bank of England would look to avoid.
One factor that could provide relief in the coming months, alongside an ongoing adherence to fiscal prudence, is the easing of energy supplies in Europe, given governments’ hasty accumulation of alternative energy sources, particularly liquified natural gas. This would also help to close the UK’s sizeable trade deficit. Longer-term challenges persist, including weak productivity growth and structurally higher social spending. However, these issues are common across advanced economies and are by no means a UK-specific challenge, they are also amply reflected in current valuations, in our opinion.
Dwyfor Evans, head of Apac macro strategy
State Street Global Markets
Monetary policy takes centre stage ahead of a full detailed UK Autumn fiscal statement later in November. QT will provide a test of investor demand for UK Gilts, although auctions are modest in size. Leading into these events, investor positioning in Gilts and GBP were entrenched underweights, a reflection of negative sentiment during the previous administration.
Gilts are likely to wait until the Autumn statement for direction and while the Bank of England (BoE) has promised a hawkish response to high and stubborn inflation, market expectations on rates have moderated on the change of government and the signals around fiscal policy. If Gilts react poorly to a ‘mere’ 75bps hike from the BoE monetary policy committee (and the QT auction), and if GBP weakens broadly, they will be telling signals that a new government alone cannot solve for the drag of deepening stagflation. We would remain cautious on UK assets at this juncture.
Ken Shih, head of wealth management Greater China
Rishi Sunak’s victory may have resulted in a short-term reduction in political volatility, but investors should be aware the road ahead will be challenging from a policymaking perspective for the new Prime Minister. For UK stock markets to properly recover, it comes to coming up with a good economic policy and reviving investor confidence.
Initially, markets responded favourably to Sunak’s appointment with gilts falling sharply and the FTSE even closing up slightly into the end of October, but this is losing steam as we start November. From a macro perspective, there are still a lot of unknowns when it comes to UK assets. Although UK assets are undervalued (FTSE trading around a PE of 11x), there is little the new leadership can do to prevent the upcoming recession or bring back asset allocation to UK assets.
The same goes for the Sterling which tried to rally unsuccessfully recently, and its challenges extend beyond just the strength of the USD dollar. Given the binary outcome and the potential macro headwinds ahead, we would remind investors to err on the side of caution when considering UK risk assets.
Hartwig Kos, head of multi asset allocation
The recent turmoil in the UK has opened up a range of potential investment opportunities. Some of them have already passed. But most of the opportunities unfortunately remain in the waiting.
As to the opportunities that have passed, the volatility in the UK Gilt market, which was exacerbated by the ill-conceived mini budget of the former Chancellor Kwasi Kwarteng, was a very tradeable investment opportunity. Given the regulations around UK Pensions and the positioning of UK pension funds, it was inevitable that the Bank of England would be forced into supporting the Gilt market.
As for the opportunities in the making, rapidly rising UK mortgage rates paired with the short-dated financing of UK properties is forcing owners (commercial and residential) into selling their properties. As supply comes to the market, and financing remains expensive and difficult. Cash buyers do potentially have access to very interesting investment opportunities in the next 12 to 18 months.