With May Day done, the starting gun has been fired on what will surely be another British impersonation of summer, primarily lacking sun. Meanwhile, incoming economic data tell us that the economy looks similarly vitamin D deficient, with consumer demand for credit wilting and the residential housing market with it. Worse still, pretty much all of the UK’s oft-derided neighbours seem to be basking in economic warmth, as they have been for much of the last year or so. If all that wasn’t enough for patriotic capital markets investors, the UK’s stock market is currently one of the world’s least-loved, as its relative slump illustrates, and you will still incur a real loss by lending to the government for 10 years.
Admittedly, we are not expecting the economic backdrop to improve dramatically in the coming weeks and months. Progress has been made on the terms of Brexit, but sufficient uncertainty lingers to influence some corporate decision making. However, life is getting a little better for the UK consumer. The economy has almost digested the imported hump in inflation, leaving the UK consumer’s real wage growth back in positive territory. This should leave them with more room to bring a little sun to the economy in the year ahead.
Longer term, the threats and opportunities for the UK economy remain roughly the same. Even after the likely painful process of disentangling the UK from its largest trading partner, the economy should continue to benefit from a flexible and growing workforce, first-rate institutions and a stable rule of law. These will remain important, and domestically underestimated, considerations in the perpetual battle to attract international investment and capital flows.
On the other hand, as we’ve pointed out before, it would be suicidally inept for the EU to allow the UK leave its club with better or even the same terms of trade that it enjoyed on the inside. Alongside that extra friction with our most important trading partner in both goods and services, the UK’s trend growth rate should also be crimped by the lower levels of immigration long promised by this Conservative government.
Migration is certainly controversial from a political standpoint as the last few weeks (years) have amply demonstrated. Through an economic lens, the picture is much clearer however; the evidence points to migration being a net benefit for the native population. High-skilled migrants bring diverse talent and expertise, while low-skilled migrants fill essential occupations for which natives are in short supply, allowing natives to be employed at higher-skilled jobs. Alongside this, migration inflows do not just expand labour supply. They may also boost labour demand, since the availability of cheap foreign workers is thought to encourage companies to invest in the UK. Further increased employment obviously then boosts consumption and housing demand.
Ironically, the UK may well find that immigration from the EU drops fairly dramatically in coming years with or without Brexit, as some of the principal drivers of the surge in EU immigration seen over the last decade continue to wane. A failure to introduce transitional controls to A10 accession countries in 2004 saw migrants from the former Soviet Union pulled to the UK by the promise of higher wages. However, with income levels in Eastern Europe converging with the wider European Union and the UK economy likely entering a softer spell, some of the motivation for this migration may recede. Alongside this, the terrible economic privations suffered by peripheral Europe in the aftermath of the Great Recession that helped drive many of their more mobile workers to emigrate are also fading fast.
In the aforementioned global economic context, it is not the subdued state of the UK economy that hampers the popularity of the FTSE, but its unfavourable sector composition and weakening relative profitability. With high representation of defensive industries such as pharmaceuticals and consumer staples, the FTSE tends to be left behind when animal spirits are rising around the world. Still, longer term investors who have a domestic bias would be right to be interested in the 4% dividend yield currently on offer, particularly relative to 10 year gilts offering just 1.4%.
Much like its weather, the outlook for the UK economy remains murkier than for many of its peers. Disentangling the UK from the EU will be costly and likely more time consuming than many currently assume. The political backdrop could easily get less helpful too. However, remembering that the UK’s corporate sector tends to be more adaptable and resilient than feared, forged as it has been in the white heat of global competition, provides important investing context. The FTSE sits low down the pecking order of our developed world favourites at the moment, but that should not deter the longer term investor from having at least some exposure.