Investors are ignoring the masses of outstanding debt that the government has built up as well as the economic malaise in Europe when assessing the political headwinds facing the UK, according to Franklin Templeton’s Colin Morton.
The Franklin UK Equity Income fund manager believes that, while the market has reacted positively to the election of a Conservative majority government, there are issues that are being overlooked by many investors.
Performance of indices since election
Source: FE Analytics
“[The market’s reaction] is perfectly plausible because as we were going into the election we had fears surrounding the potential for a coalition, a hung parliament, a minority government, and the real concern was that it may have taken weeks if not months for the 
government to settle and for us to come up with a prime minister,” he said.
“Obviously that could have been a pretty dire outcome because of the uncertainty and not knowing what the policies would have been going forward. I think the positive now is that, whatever your political view of the situation is, the fact we’ve got a major party as a majority is a much better outcome than the market was perceiving.”
“On top of that, the Conservatives from a stock market point of view and from a business point of view are generally seen as much better news than a left-wing Labour party, so the market’s positive response was to be expected.”
However, he argues that this sense of relief is masking some longstanding challenges that need to be dealt with.
One of the biggest issues that Morton (pictured) flags is the difference between the £90bn annual deficit and overall government debt, which he believes is either ignored or misunderstood by the vast majority of the voting public.
While he notes that the coalition government reduced the deficit significantly from the approximate £170bn it once was, he says this is far from adequate.
Many investors fail to grasp the fact that the UK’s entire public debt is much higher that frequently cited deficit figure, following years of the government spending more than its revenues.
“There’s something that’s missed in all of this by a lot of people and the politicians are very much to blame because they go round saying things like ‘we’ve halved the deficit’ and you could forgive the person on the street for thinking ‘oh well we’re a lot better than we were, we’ve got half the deficit’,” he said.
“What the government is failing to explain to the public is that it’s an annual deficit – that is how much more we are spending over what we’re taking in, so we’re still spending £90bn more rather than £170bn more. You have to ask – what does this all add up to and what is the outstanding deficit?”
The UK government currently owes almost £1.5trn. According to Morton, this increased by more than £650bn while the coalition government was in power and was the biggest addition to the UK’s national debt at any one time in recent history.
Adrian Lowcock, head of investing at AXA Self Investor, said: “The Conservatives will have an election budget on 8 July and we’ll see austerity re-commence. But we don’t know how big it’s going to be, how long it’s going to last for, and what that means – what does austerity mean?”
“Lots of jobs have been created in the private sector over the last five years so, while it’s been unpleasant, we’ve still kept employment coming down. But it could continue to impact on the market – we may see volatility ahead of the budget and after the budget.”
While austerity measures have provided some economic benefits, Morton points out that the timescale the country has to re-balance the books also needs to be addressed.
He says that, while international bond rates are low, the need to pay back debt at the moment is reasonably relaxed.
“Everyone seems to be in trouble globally so, even if the UK’s balance sheet isn’t great, lots of countries are in worse situations than we are,” he reasoned.
“These [debt figures] would normally be very scary numbers and the worry is that one day the markets will wake up and all of a sudden bond yields aren’t 1 per cent any more, bond yields are what they used to be at about 5 or 6 per cent.”
“Of course, we couldn’t finance the debt we’ve got at those sorts of levels. Even at these current rates of interest, it still costs the country £50bn a year to finance its debt. Can you imagine if interest rates start to go up towards 3, 4, 5 per cent and we have to re-finance those gilts as they come up for redemption? You’re talking about significant cost increases for the country.”
“So we have got to get that deficit under control and that hasn’t really changed regardless of who’s in power.”
Another major problem for the UK, according to some financial experts, is the number of headwinds facing the European economy and how these impact the domestic economy.
One of which is the weak euro. Over the last six months, the value of the euro has decreased by 10.35 per cent compared to the pound, according to FE Analytics.
Performance of currencies over 6months
Source: FE Analytics
Lowcock said: “We’ve got issues with a strong currency against Europe and Europe is a major trade partner, so that’s obviously a concern as it makes the UK very uncompetitive against the eurozone. However, this could be resolved if we have a recovery in Europe.”
While Morton agrees, he believes the odds that Europe will bounce back in the near future remain slim.
“It’s not just a case of QE trying to get the economy moving again, it’s the structural issues in so many of the economies,” he explained.
“Countries like France and Germany have done absolutely nothing to change their economy in the last five or 10 years – they’re still running a very socialist model.”
“It’s moving a little bit but it’s very hard for businesses to get rid of people, very expensive to employ people. It’s still incredibly expensive in terms of welfare – retirement and all these sorts of things in places like France have hardly improved at all.”
Despite warning that there are structural issues that need to be resolved in Europe, Morton concedes that the continent is economically far sounder than it was a few years ago and that the European Central Bank is starting to “step up to the plate after dilly-dallying for a number of years”.
“To us, though, it’s very difficult to all of a sudden see this huge growth,” he added.
“Going forward, we’re prepared for relatively low economic growth, relatively low inflation, and a lot of work will be needed to try and find companies which can do reasonably well in that type of environment.”