Please see below this yesterday’s global market round-up from Brewin Dolphin, which was received late yesterday afternoon – 28/05/2024:
The event which seemingly caught the world off guard last
week was the announcement of a UK general election, which
will be held on 4 July. The papers on Thursday morning were
rife with stories of cabinet members being kept in the dark,
and many asked why an election would be called now when
the Conservatives lag so dramatically in the polls.
Theoretically, an election could have been held as late as
next January, but that would have required campaigning
over Christmas (which is not something voters would have
appreciated). The working assumption had been that the
election would take place in November.
Last month, we questioned that assumption:
“…an established preference exists to not have elections
coinciding amongst members of the so-called Five Eyes
intelligence collaboration alliance (driven by the U.S. and UK
and incorporating Canada, Australia and New Zealand). The
perception is that a change of power in these countries can
complicate their responses to signals intelligence. The UK and
U.S. electoral systems tend to mean complete changes in the
executive government, rather than the evolving coalitions seen
in other countries, which heightens the risk.”
So, there lies a political, or at least non-economic, reason not
to have the election in November. Was it meaningful? It hasn’t
been cited as such; instead, the decision is rumoured to have
been made after the local elections, which were predictably
terrible for the Conservatives, but perhaps not decisively great
for Labour.
The economic rationale for a July election
Economic motivations seem clearer. The most obvious reason
for calling a July election is the inflation rate announced on
Thursday morning.
The figures showed a relatively sharp decline in the inflation
rate, from 3.2% to 2.3%. This bookended a period in which
the UK, which suffered unfortunately high inflation rates for
many months, has seen a significant improvement in inflation
figures (it peaked at more than 11% in late 2022 and was still
nearly 9% a year ago).
The so-called base effect drove the decline in inflation that
caused the apparent slowdown. This was therefore more a
reflection of last April’s price increases dropping out of the
numbers than this April’s price increases being particularly low.
To a lesser extent, the same thing will happen next month,
providing a continuing narrative of lower inflation as we
approach election day. The controversy is what happens after
that, because the strength of services inflation in Wednesday’s
report might cause prime minister Rishi Sunak to worry about lingering inflationary pressure, like that seen in the U.S. this year.
Another measure for underlying inflationary pressure is the
monthly change in median prices, which has been picking
up recently.
The other reason for thinking last month that an earlier
election might be on the cards was public finances, which
were worse than the Office for Budget Responsibility (OBR)
predicted at the Spring Budget:
“…these latest data suggest UK finances are getting tight.
There will be little point in holding a fiscal event if there is no
scope for further tax cuts. If forecasts are excessively optimistic,
the risk is that fiscal policy might need to be tightened, a
politically unpalatable prospect both parties are hoping to
postpone until after the election.”
Another month’s public finance figures were announced
on Wednesday. Although they were overshadowed by the
inflation news, and then the election announcement itself,
they have deteriorated again, and OBR forecasts will need
to take account of compensation payments due in respect
to the NHS contaminated blood scandal as these become
sufficiently certain.
The scope for tax cuts is therefore falling. Meanwhile, growth
is relatively good for now, bouncing back from a technical
recession in the second half of 2023. Unemployment is
relatively low, but jobs growth has been slowing, so there
is more scope for joblessness to rise than decline.
So, overall, the economic backdrop for a 2024 election might
not get much better than this.
While the rationale for an early election may exist, it doesn’t
mean the government will prevail. Indeed, according to polling
and election forecasters, a substantial Labour majority seems
virtually inevitable.
Both parties will be working on their manifestos, and the
changing state of public finances will complicate their efforts,
but what do we know about their differences and what do
they hope to change?
The dividing lines between the Conservatives
and Labour
Labour has proposed several solutions to boost the British
economy, including planning reform, better EU relations, the
Green Prosperity Plan, and strengthening workers’ rights.
It aims to increase funding for the NHS, schools, childcare,
policing, and border security. To finance these initiatives,
Labour plans to crack down on tax evasion, increase the
energy tax levy, reform the non-domicile tax regime, abolish
the carried interest loophole, and charge VAT on private
school fees.
Labour also pledges to keep corporation tax at 25% and
maintain current income and capital gains tax rates.
Labour’s Rachel Reeves aims to balance the budget
and strengthen the OBR’s role. However, given the high
government interest expenses, the deficit is expected to
remain significant, with UK debt potentially rising to 300%
of GDP by 2070. Concerns about government finances will
persist for policymakers.
When the manifestos are written, likely in two or three weeks,
they will be scored by the Institute for Fiscal Studies. It’s
common for them both to err on the side of generosity. It’s
likely that the gap may be particularly wide this year, and
particularly so for Labour.
The Conservative Party has made life awkward for them
with popular tax cuts and defence spending commitments,
which Labour will have to reverse if it doesn’t want to limit
its own initiatives. So far, it has suggested it will keep
these commitments.
Since the announcement
Rishi Sunak’s election campaigning has been greatly hindered
by the weather. As well as his campaign launch speech, it
has also impacted economic statistics. If the prime minister
was looking for April’s retail sales to fit the narrative of an
improving economy, he’ll be disappointed. Consumers bought
around 3% less in April this year than they did last year. Why?
Probably because it was the sixth wettest April since 1836,
with 55% more rainfall than average and about 20% less
sunshine. Not a great shopping month.
Assuming some normalisation in weather patterns, some
catch-up spending would see May and June recover some of
that lost activity, which could give an impression of economic
momentum as we approach election day.
Could there be more sinister weakness lurking behind the
weather effects? Consumer confidence seems to have
improved over the month, and based on the best data we
can access, it seems even with a slowdown in employment
growth, aggregate real wage growth is expanding.
Away from the UK
Provisional data for economic performance in May comes
from the purchasing managers indices. They show that the
UK economy continues to perform ok. Admittedly, the service
sector seems to have slowed down markedly during May, but
even that slower pace reflects a still-healthy expansion.
Globally, the services expansion still seems to have good
momentum. Crucially, the U.S. bounced back with its
strongest services business growth in a year.
Services activity has been expanding far faster than
manufacturing, where companies have had to work through
inventories built up after strong lockdown-driven demand for
durable goods. We are hopeful the fourth quarter of 2023
marked the low for manufacturing, and the latest data support
the expectation of a continued, if slow, recovery.
The other familiar theme we’ve discussed in these notes is our
preference for semiconductors and Nvidia was among the last
companies reporting this earnings season, issuing probably
the most anticipated earnings release this quarter.
Nvidia is a good example of the real-world economic
beneficiaries of the revolution in digitisation and artificial
intelligence. Its valuation seems high, but its financial
performance is stunning. A year ago, it made $7bn of
revenue; the equivalent quarter just reported saw that rise to
$26bn. Profits have increased from $2bn to nearly $15bn.
The observation that the U.S. equity market price-to-earnings
ratio is at the upper end of its historic range is a fair one, but it
has to be seen in the context of the extraordinary companies
that have come to dominate the market.
A simple price-to-earnings ratio does not take account of the
different pace of growth or the reliability of earnings constituents may have. It partly reflects profit margins but does not
demonstrate the remarkable profitability of some members.
There has never been a time when such large companies
have been able to grow profits at such an extraordinary
pace. That is not to say that all members of the so-called
Magnificent Seven are unambiguously positive, but excluding
any of them based upon a crude measure of earnings
multiples would be unwise
Please continue to check our blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.
Carl Mitchell – DipPFS
Independent Financial Adviser
29/05/2024