Market Update 20th November 2023

The i’s have it

I have no doubt you’re all aware the Autumn Statement is just a couple of days away. The challenge for Jeremy Hunt, like all other red briefcase carriers before him, is to balance the demands of different factions of the party, the fiscal position, and the views of the electorate. All while ensuring that the benefits of any new policies are direct enough that you’ll get the credit. There’s no point laying the foundation for something that the next inhabitant of 11 Downing Street will get the plaudits for. Oh, and it’s very important to have a ‘rabbit from the hat’ – a phrase that is nice enough but gets wheeled out annoyingly frequently around these announcements.

In terms of where changes could come from, it seems Jeremy Hunt has taken inspiration from the speaker. Apparently, the i’s have it.

Let’s start with the first i: Inheritance tax. Casting aside political or moral points, one can see the reasoning. It only raises about £7bn a year. Current consensus has the Chancellor with enough headroom to make £10-15bn of tax cuts or spending increases and still meet his targets on debt.

Of course, there are reasons it could be untouched. While it may only raise £7bn now, changes would see the exchequer lose out on greater windfalls in the years ahead. The Institute for Fiscal Studies thinks the take will more than double in the next 10 years (a growth rate of roughly 8% a year). That’s a lot to give up. There is a curious juxtaposition in the optics to consider too. While the concept of taxing the dead is deeply unpopular, giveaways to middle & upper classes would do little to win or retain many of the seats that matter. With an election around the corner, this is important.

Other i‘s up for tweaking include income tax and ISAs. Not moving the personal allowance was one of the ‘stealth’ tax increases that have contributed to elevating the tax burden to the highest for 70+ years. A more universal giveaway would please the many Conservative MPs in areas Labour will be targeting.

Few are expecting major reform to ISAs, but I would be supportive of changes that make it easier to invest. For example, the Lifetime ISA could be simplified, or there could a change around fractional shares. Fractional shares are exactly what they sound like, and help break down barriers to investing. A direct investment in each of the ‘magnificent seven’ costs a minimum of £1,500 – and that gets you just one share in each. This creates a particular grievance for younger investors, a demographic Sunak et al find it difficult to reach.

The process of drip-feeding leaks to journalists reminds me just how funny Yes, Minister is. The Thick of It offers a more recent take that includes Peter Capaldi using far more creative language than the Doctor Who writers permitted. Most certainly post-watershed.

To be honest, there’s not too much funny about the UK’s public finances, despite the headroom the Chancellor apparently has for giveaways. I did a back of the envelope calculation the other day which illustrates the point. If one looks at the cost of refinancing only the conventional debt maturing in the next three years (ie ignoring the index-linked obligations) the extra annual interest cost could increase by £10-12bn at current rates.

The good news here is that, if held to maturity, these investments are as close to risk-free as you can get, given they have guaranteed cash flows for as long as the government is not in default. Yields to maturity are generally 4 to 4.5% even after a bump in the price of bonds (which depresses yields) and for many low coupon gilts, the vast majority of that return is not taxable. Remember the capital gain on gilts is currently exempt from CGT. We may not be out of the inflationary woods yet, but I’d expect inflation to average under 4% in the next few years, so the return on UK government debt

means they now have a tax-efficient, positive real return on offer for the first time in a while. This is not a bad place to start an investment conversation.

As ever, the more exciting asset classes have more potential upside, and greater risk. Equity markets can, and will, be volatile at times. But companies are not in bad shape at all. A look at major UK and US indices tells us that relative to historical averages, profitability levels are high, and debt ratios are low. Earnings momentum is pretty strong. With almost all large US companies having now reported, 82% have posted better than expected numbers. It’s normal for there to be more good results than bad, but that percentage is higher than the 10 year average. The size of the positive surprise is also, on average, larger than normal. Analysts are relatively upbeat about earnings growth next year too. Forecasts are for around 4.5% in the UK, and more like 11% in the US.

Factor in the prospect of some interest rate cuts and a far less demanding valuation backdrop than in recent years, 2024 could be a good year.

However, there are tripwires. Any companies missing targets are being very harshly treated, and have been sold off by more than usual. This is perhaps because the market is skittish about the macro, and sees potential for the situation to get worse before it gets better. That’s reasonable when we still haven’t felt the full force of the interest rate hikes yet. They generally take around 12-24 months to come into effect.

My overall perspective is, as usual, unchanged. I believe equity markets will create value over the long term. I wouldn’t do this job if I didn’t. But given the challenges of predicting the short term ups and downs, now more than ever, it’s best to stick with high quality, resilient companies.

George Salmon – Senior Investment Analyst

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