In a wide-ranging interview, Simon and Sarah dissected the medium term economic outlook and how it will impact mid-cap companies. First, though, was the subject of Brexit and the Trump presidency.
“I think it’s remarkable how little equity markets have been impacted by geo-political turbulence,” Simon said.
“We haven’t yet seen the implications of that in terms of the manifestation of Brexit, but also some of the protectionist rhetoric from the US. That hasn’t actually played out. Markets are cautiously optimistic but are also mindful that that campaign rhetoric may yet be translated into actions."
“I think it’s inconceivable that the popularism that was driven in 2016 won’t have profound economic consequences somewhere down the line. The challenge for investors is which sectors will that hit versus which will effectively dodge the bullet.”
In his Mansion House speech in June, Mark Carney, governor of the Bank of England, said that it would be wrong to raise interest rates until we know what’s going to happen about Brexit. Sarah asks, was he right about that?
“Personally I think he is right, although it has to be said that he has come in for some criticism for what was an emergency cut in interest rates and additional quantitative easing in August last year at a time when actually the UK economy then performed quite well.
“Is Mark Carney on the wrong side of the debate here? I don’t think so because I think there are structurally deflationary factors in the world economy holding down inflation. And what you’re seeing at the moment in terms of above target inflation is really a response of the collapse in the pound and the bounce back in commodity prices. Once those start to leave the system in the second half of this year, going into 2018, will inflation be back at the 2% per cent target, or indeed below? That’s my base case and therefore no argument from where I’m sitting for an immediate increase in UK bank rate.”
So, where are the opportunities regarding Brexit for mid-cap companies? While Simon acknowledges that there are many challenges in the market, he said: “There is the big hope around third party country trade deals that the European Union didn’t permit the UK to do as a member of the EU…The UK outside the customs union, outside the single market, can do those third party trade deals.
Meanwhile, what are investors’ thoughts on the economic outlook now?
“The challenge has been for what happens to the more domestically focused companies who are exposed to trading areas, construction, the housing market, potentially parts of government outsourcing, which have an uncertain period of time over the next two years. We’re seeing some of those valuations pull back. I think for companies in the market and looking to come to market, the market remains open, and certainly remains open for growth businesses, true disruptors. But for companies that are built on the status quo where that status quo may be uncertain going forward, it’s understandable that the buy side, the institutional fund managers, are taking a more cautious stance over the next couple of years.”
And, the question that everyone wants answered: where can investors expect to find value?
“There’s particularly bearish sentiment around consumer discretionary stocks in the UK at the moment. The reason being that you’re seeing the compression of incomes, real wage cuts this year as a result of inflation outstripping wage growth. A lot of the money that consumers have at the end of every week, every month, they go out and spend in shopping centres up and down the country. There is a sense that that will be pulled back over the next year or two. Now I’m more optimistic, and therefore I think there’s value in some of those attractive valuations in the consumer discretionary space because I do think those inflationary pressures are about to peak and we’re about to see a less inflationary environment.”