Brexit uncertainty lingers...

Andrew Milligan

The UK retail sector continues to struggle, Brexit uncertainty hangs over the economy and Europe continues to languish. What does all this mean for investors?

Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, considers the future of the UK retail sector and how Brexit is affecting the future path of interest rates. He also considers if tech stocks can continue to perform well into 2019, the outlook for European businesses, how markets are responding to political decisions such as the US tightening Iranian oil sanctions, and what the Indian election results might mean for India’s economy.


UK high street falls on troubled times

The UK retail sector continues to suffer as consumer behaviour evolves. The rise of e-commerce and online spending has not only affected the high street and shopping centres in the UK but indeed in most other advanced economies too.

According to some estimates, internet sales are now 20% of overall retail spending. All this is causing major problems for well-known high street names such as Debenhams, while firms such as Toys R Us and Maplin have already shut down. Despite this, it’s worth noting that total consumer spending is growing steadily, supported by high employment and steady wages growth. We’re seeing a change in spending habits too, with leisure spending on the rise, while clothing or consumer goods aren’t doing as well.

Many firms are seeking Company Voluntary Arrangements, which let struggling businesses restructure their estates – and often force their landlords to lower rents. Rental growth for the retail sector averaged 1% a year over the five years to 2017, but fell to -2.1% in 2018. Capital values for retail properties are also coming under pressure as shops leave the high street and focus on the best of the out-of-town retail parks or other prestige sites.

The impact adds up when you consider that the retail sector is worth about 30% of all commercial property in the UK.

At Aberdeen Standard Investments, we see only limited prospects for the UK property market in the next few years. As such, our funds are quite neutral in UK commercial property – and it’s not an asset class we favour in many other parts of the world either. However, location really matters – an example of retail properties which we believe offers a good opportunity is well-located food and convenience retail close to transport hubs in major global cities.

Politics impacts Bank of England interest rate decisions

The economic numbers might suggest it’s time for the Bank of England (BoE) to raise interest rates, but politics tells a different story. For now, the BoE is battling the uncertainty from Brexit negotiations, as well as the slow but inevitable upward trend in wages as employment rises.

Unemployment falling, the pace of employment growth rebounding, and average weekly earnings reaching a post-financial crisis high have led to a recovery in household income growth and have helped to support household spending. But, while UK politicians continue to debate Brexit, the economy is flat lining under a ‘fog of uncertainty’.

Faced with this set of circumstances, we expect the Monetary Policy Committee to keep rates on hold until a way forward on Brexit has been agreed. Making clear judgements on rates is hard without more clarity from politics, but the BoE will have to provide its latest thinking in the May Inflation Report.

US tightens Iran oil sanctions

Politics can affect markets. US Secretary of State, Mike Pompeo, has announced that the US won’t issue any more waivers to countries importing Iranian crude oil. This means that eight countries currently exempt from US sanctions if they buy oil from Iran will face penalties if they continue to do so after 2 May.

Investors are keen to understand what this means for markets. However, the situation is quite complicated.

The oil market was already under some pressure, due to lower supply from countries such as Venezuela, before the Trump administration decided not to issue any more waivers on Iranian oil exports. There’s uncertainty about how importers such as China will respond, whether Iran can find new ways of circumventing the sanctions and whether Saudi Arabia keeps to its agreement with the US to expand supply. President Trump certainly won’t want to see high gasoline costs in the US as the road trip season begins.

With oil prices currently between $70 and $75 a barrel, at the time of writing, there still appears to be room for further rises. Traders rely on momentum and they’re piling back into long oil positions – meaning they expect that the stock will rise in value in the future. However, as and when the oil price reaches $80-90 a barrel, we expect more shale producers in the US to expand output as additional fields become profitable. This may explain why the share prices of oil companies are lagging behind even though the cost of oil has risen.

A mixed outlook for tech giants

So far this year, the tech-heavy Nasdaq Index is up more than 20% as better-than-expected earnings reports eased concerns about a slowdown. But when looking at tech stock performance, it’s very important to differentiate between the different types of tech. For example, Alphabet/Google has returned to its July 2018 highs, and Apple is approaching its October 2018 highs, but Facebook has performed far less well as it faces stricter regulations.

There’s a lot of uncertainty in the outlook for some tech stocks, with share prices of firms such as Twitter significantly affected by reports of changes in subscriber numbers. These consumer-type stories are on top of weaknesses in other parts of the tech sector. For example, there are serious concerns about whether the smartphone cycle will begin to recover in the second half of the year.

Across most regions, we see software stocks and select internet stocks as attractive long-term investments. We also favour firms which produce semiconductors and firms involved in other parts of the supply chain over traditional hardware companies.

Europe remains in the doldrums

The manufacturing sector recession is continuing in Europe, especially in countries such as Germany and Italy, although overall consumer spending is holding up and preventing a recession across the whole economy.

Some key sectors such as autos remain very weak. Threat of a trade war between the US and Europe, plus the slow progress on Brexit, also haven’t helped business sentiment.

On the plus side, the European Central Bank (ECB) is clearly hoping that the turnaround we’re beginning to see in China will feed through into global trade and European exports by the summer, while high levels of employment and low interest rates are supporting key areas such as housing. All in all, the ECB looks to be in ‘wait and see’ mode – as do global investors. We remain neutral on European equities at present, looking for individual stocks which are attractively priced and have global potential.

India awaits election results

General elections are under way in India. By the end of May we should know if the Bharatiya Janata Party (BJP) will remain in power under the current Prime Minister Narendra Modi, or if the Indian National Congress (INC) under Rahul Gandhi will return to power. We could even see a coalition.

In terms of the Indian stock market, bonds and currency, it’s always useful to assess what’s already been priced in. Indian markets are generally pricing in a victory by the ruling BJP when the results are announced on 23 May. Prime Minister Modi has built his campaign around national security and fighting terrorism, plus some giveaways to select parts of the electorate such as farmers.

Sadly it’s hard to see India’s equity rally running very far. Although the stock market has hit new records, buoyed by a rush of foreign investors betting on Modi’s return, dovish monetary policy in the US, and further good news from China, equity valuations are rather expensive.

Recent interest rate cuts will support the Indian economy. However, the outcome of the election is unlikely to have an impact on economic activity to any great extent in the medium to long term, unless a non-BJP and non-Congress coalition government is formed. The manifestos of the two main parties have revealed a similar focus on employment generation, infrastructure growth, private investment, manufacturing, simpler taxes, rejuvenating agriculture and encouraging small and medium enterprises. As with any election, we’ll have to wait and see how many promises are actually met in reality.


The information in this article should not be regarded as financial advice. Please remember that the value of your investment can go down as well as up and may be worth less than you paid in. Information is based on Aberdeen Standard Investment’s understanding in May 2019.