The positive outlook for the UK economy this year is unlikely to reflect in the behaviour of the FTSE 100, according to the latest report from Capital Economics, who warned last week that the blue-chip index is likely to achieve a sideways return in 2017 from here.
However, many UK equity fund managers are less positive on the economic backdrop for country but more optimistic when it comes to the FTSE 100’s performance in 2017.
This comes as the second part of a series, which breaks down the four main reasons why Capital Economics believes the FTSE will stagnate.
Following on from his first point that sterling weakness has run its course, assistant economist Andrew Wishart said: “The continued resilience of the UK economy will provide less of a boost to the stock market ahead.
“Recent gains in the FTSE 100 have been replicated in the FTSE Local index, which is made up of firms which earn the majority of their revenue domestically, reflecting the fact that the economy has confounded expectations that it would slow sharply in the wake of the EU referendum result.
“While we still expect the economy to outperform the consensus forecast, further upside surprises should be small given previous revisions to expectations.”
In the below graph, we have used the FTSE 250 index to represent the performance of domestic-facing stocks relative to the FTSE 100.
Performance of indices over 1yr
Source: FE Analytics
Trevor Green, head of UK equities at Aviva, is less convinced that the UK economy will perform strongly for the rest of 2017.
“The resilience of the UK economy is open to debate,” he reasoned. “With the consumer under pressure and political uncertainty prevailing, this may have a negative effect on investment spending by companies in the UK until there is greater clarity on how Brexit discussions are going.”
Adam Laird, head of ETF strategy, northern Europe at Lyxor, echoed Green’s stance on the health of the UK economy this year and that its outlook is likely to be bright.
“Investors’ sentiment on the FTSE 100 has been negative throughout 2017,” he explained. “So far this year (to 22 June), just €37m has flowed into FTSE 100 ETFs. That is almost insignificant considering FTSE 250 ETFs have seen more than €250m in inflows. Fears over Brexit and the potential for harm to the UK economy have pushed investors away.
“Overall we are cautious on the UK but I don’t think there’s reason to abandon ship altogether. The FTSE 100 still contains many good businesses with global reach. It’s difficult to write these all off. Indeed, the FTSE 250 with its domestic focus may struggle more in the short run.”
Alan Custis, who manages the four crown-rated Lazard UK Omega fund, agreed with Green’s concerns regarding the UK consumer. He said rising inflation, combined with increased leverage among UK households, could certainly be a headwind for the UK economy.
“We don’t think the UK economy is going to be that resilient in the first place,” he said. “We called it wrong to a degree last year because, post the referendum result, we thought we would see a degree of weakness and I think a lot of other commentators were also surprised at the strength of the UK economy in the aftermath.
Performance of index since 23 June 2016
Source: FE Analytics
“But, I think what we’re seeing now a year on is that the weakness is starting to come out. What we do know is that the savings ratio has come down quite a lot; people were spending but they were spending from their savings rather than from income last year.”
The head of UK equities explained that unsecured lending has increased significantly over the last 12 months, which is a factor the Bank of England is particularly concerned about.
“I think there are reasons to be cautious on the UK at the moment,” he continued. “There are pockets where that caution is not warranted at the moment – housebuilding continues to be driven by Help to Buy – but I think we have had quite mixed messages coming from consumer-facing sectors.”
Phil Harris, who heads up the EdenTree UK Equity Growth fund, said it felt as though economic forecasts were very low at the end of last year and as though they were due to upgrade substantially.
However, he thinks the positive forecasts seen during the latter half of 2016 for this year may pull back now.
“Of course, it matters on the make-up of those [forecasts],” he pointed out. “It is likely that we will surprise on the upside in terms of exports but it’s possible it will underperform for the consumer, which is of course a majority of the UK economy.
“We might see a headline GDP number that looks okay, but the make-up may be slightly different to perhaps what we wanted and to what investors originally thought as well.”
Richard Penny, who runs the four crown-rated L&G UK Special Situations Trust, is more positive on the outlook for the UK economy as resilience in the UK year-to-date has meant that profits among UK-led businesses haven’t reduced. However, he pointed out that the UK economy only accounts for around 20 per cent of the FTSE 100’s revenue.
“The most recent quarterly updates have seen slightly weaker trading momentum within the realms of UK-focused consumer businesses, but stronger trading for exporters,” he argued. “Capital investment and employment have held up well.”
Robert Scammell, senior portfolio manager at Kempen Capital Management, agreed that domestic UK economic performance matters far less than international economic conditions when it comes to the FTSE 100’s performance.
He said: “The outlook for the European economy seems to have turned around significantly in the last 18 months and US economic conditions remain relatively benign with high consumer confidence, low unemployment and rising output indicators.
“The Fed has been raising rates for some time and the ECB has recently changed its outlook bias. However, this is in response to economic strength and the fading prospects of deflation.”