Brexit dominates the headlines

Andrew Milligan

Of course Brexit is dominating the headlines in the UK, with Boris Johnson’s plan to suspend Parliament for a month. Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, looks at what’s currently happening in the UK, and what this means for markets and investors. He also considers the possibility of recessions in the US and Germany, and whether currency and debt issues in some emerging markets are having a wider impact.


Brexit uncertainty goes on

With the political situation surrounding Brexit moving dramatically by the day, it’s difficult to be certain about the possible outcome and implications for financial markets. As we’ve highlighted for some time, we focus on currency markets first to assess what’s in the price.

The movements we’ve seen in sterling have been quite logical in response to the waxing and waning of probabilities around a hard Brexit or no-deal Brexit, or a general election or an article 50 extension. The implications for FTSE® 100 vs FTSE® 250 stocks or for gilts vs European bonds are various ways in which some investors have been putting their preferences into portfolios.

On balance, we remain pretty neutral on sterling assets until the political picture is clearer. Overseas investors have generally been underweight in them, although in recent weeks a more attractive dollar vs sterling scenario has encouraged more merger and acquisition activity by foreign companies looking for attractive businesses to buy.

The UK retail sector is feeling some pain

According to the Confederation of British Industry (CBI), in August high-street sales fell at their fastest rate since 2008. This is a concern, and illustrates the pain many high-street retailers are feeling. There’s no doubt that consumers are nervous about buying big ticket items with so much uncertainty around Brexit. But we also need to look at the wider context – the long-term change in consumer behaviour towards more online purchases, plus spending more money on ‘experiences’ rather than ‘stuff’. And the weakness in high-street spending in the UK is no different to the experience of most other advanced economies.

The implications for investors are clear – find the winners and avoid the losers. In practice, we believe that means looking for the leaders in e-commerce, and those parts of the property market related to logistics and the entertainment industry rather than the now rather old-fashioned high street or shopping centre.

More positively, there’s record employment in the UK

Amid all the doom and gloom, it’s important to remember that the UK economy, like most major economies, is actually performing quite well. Policymakers have managed to create sufficient activity in the economy to drive unemployment down to historically low levels.

Of course, questions can and have been asked about the quality of some of these jobs in a ‘gig’ economy. But on balance, most people are in work and seeing real income growth. That explains why, despite some nervousness around Brexit and other geopolitical risks, consumer confidence is generally high and there’s growing household consumption.

The main risk we see ahead is some major shock to the labour market causing people to pull back and save. We’re watching the monthly employment reports in all the big economies with great interest.

And the FTSE® All-Share Index has been rising this year

Despite Brexit uncertainty, and global issues such as the US-China trade wars and Middle East tensions, it’s worth noting that the total return from holding the FTSE® All-Share Index is approaching 10% since the start of this year (at the time of writing). On top of share price moves, there’s the effect of dividend payments, dividend growth, share buy-backs and special dividends. Investors mustn’t rest on their laurels though. Looking ahead, we need to think about what events could hurt company cash flows and their ability to continue to make dividend and bond payments to investors.

Unfortunately, the list of events to worry about is quite long. On top of the normal political strife and geopolitical stress, structural changes are taking place in many industries: technology advances, increasing regulatory oversight and higher costs. All in all, we forecast that companies will generally see fairly modest profits growth into 2020. So our emphasis is on higher-quality companies with strong balance sheets rather than very cyclical or exposed stocks.

Further afield, there are concerns about the US and German economies

There are mixed views about the outlook for the US economy. President Trump has been very vocal in his view that the Federal Reserve should cut interest rates to support domestic activity. But minutes from recent Federal Reserve meetings show a wide difference of views among members about the outlook for the economy, and how quickly interest rates need be cut further.

That’s why the Federal Reserve’s Chairman, Jerome Powell, has been at pains to say that any decision on further rate cuts will be data dependent and probably move more slowly than the ever-eager bond markets have priced in. We expect two or three more cuts by next spring, which should be enough to stabilise the economy. But further improvements in the US economy will rely on no further policy mistakes by the White House and preferably some form of trade peace with China.

Closer to home, Europe faces risks too. All the signs are that a modest recession is very likely in the German economy this year; indeed, the Bundesbank has warned as much. The main cause is the pressure on the important manufacturing sector, partly because of the impact of global trade tensions and partly because of problems within the German auto industry. This hasn’t come as a great surprise to markets as business surveys have been weak for some time, and took a turn for the worse over the summer.

The good news for Europe as a whole is that other countries, such as France and Spain, are holding up better. And even within Germany, some sectors, such as property, are very buoyant on the back of historically low interest rates. All in all, Europe remains a stock picker’s market until the European Central Bank’s actions around quantitative easing and interest rate cuts are seen to bear fruit.

And concerns about emerging market economies

Argentina and some other emerging market economies have indeed been in the news recently – generally for the wrong reasons. These include concerns about whether loans will be repaid and worries about poor policy decisions. On balance, however, most emerging market economies are in a good state, as long as a full-blown trade war between the US and China or a major surge in the US dollar are avoided.

Current account positions, fiscal deficits and other potential risks in emerging market economies are generally manageable. And against a backdrop of lower inflation and steady reductions in interest rates, we like the high yields which many emerging market bonds can offer. Selected equity markets are also attractive due to valuations and the prospects for future profits growth. As ever, country selection in emerging market assets remains vital.


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 September 2019