What does the mini-budget mean for the stock market?

Making good on the Prime Minister’s pledge to cut taxes, the mini-budget:

• Reversed (from November) the 1.25% hike in National Insurance that was implemented earlier this year
• Cut basic-rate income tax from 20% to 19% in April 2023
• Did away with the 45% additional-rate tax for higher earners (doesn't apply in Scotland) from April 2023
• Increased the stamp duty threshold in England and Northern Ireland to £250,000 (£425,000 for first-time buyers)
• Cancelled the 1.25% increase on dividend tax rates from next April
• Scrapped the planned hike in corporation tax to 25% from 19%
• Announced the creation of low-tax ‘investment zones’ with light-touch planning rules

Kwarteng’s target is GDP growth of 2.5% a year, which is something we haven’t seen since 2006. This was helped by an expanding labour force. In contrast, while unemployment is low today, in the three months to July, 154,000 people left the workforce [1]. This is on top of the many people who took early retirement during the Covid pandemic. Shrinking workforces constrain growth, which will add to the challenge of achieving 2.5% growth. 

What this means from an investment perspective

While this scale of fiscal expansion is bold, it is also risky.

• Borrowing will fund the shortfall on public finances at a time when borrowing costs are on the rise
• If the markets become concerned about the sustainability of public finances, this puts pressure on sterling lower, which has already plunged to lows against the dollar last seen in 1985
• A big fiscal boost to the economy could extend the Bank of England’s battle to get inflation under control. On the one hand we have rate setters pressing on the economic brakes with increasing ferocity while the UK Government has its foot hard on the accelerator. The Chancellor’s plans will be offset partially by higher interest rates

Notwithstanding these risks, there are clearly positive investment effects too.

Domestically focused companies

Businesses with a domestic focus will certainly welcome the scrapping of the hike in corporation tax and the reversal of recent National Insurance increases.

When it comes to listed companies, domestically focused stocks are more prevalent among mid and smaller-cap companies. In 2022, as the outlook has worsened, they have shed almost a quarter of their value while the FTSE 100 Index of large companies has declined around 5% since the start of the year.

Given helpful news on tax and energy costs, and with so much negativity priced into domestically focused companies, there may be a temptation for contrarians to consider investing heavily in UK small and medium-sized businesses.

We are more cautious for now. While recent measures on energy and tax may have reduced the prospect of a very deep recession a little, the domestic economy is still facing challenges. The squeeze on real household incomes is hurting consumption and big borrowing-cost increases will be painful for those needing to re-mortgage. The UK is likely already in a recession and while it may be shallower now, we see no reason for excessive bullishness towards domestically focused stocks.

UK large companies

However, large UK companies have relatively low exposure to the domestic economy along with high weightings to sectors that, in the past, have proven resilient at times like this. In aggregate, around three quarters of the revenue from companies in the FTSE 100 are made outside the UK. As much of this is in US dollars, in the near term, US dollar strength should help bolster profits and dividends when converted into sterling.   

There is also considerable exposure to energy, healthcare, and consumer staples sectors at the large-cap end of the market and, historically, these sectors have held up well during times of high inflation and struggling growth.

Valuations of large UK equities look attractive both compared with other developed markets and their own long-term trend. And they also provide a dividend yield of c. 4% [2], which is more than double that of global equities.

Many investors have shunned UK large-caps for some time now – through the Brexit days and because the market lacked exposure to exciting tech companies but times are different now. With ultra-low borrowing costs and central bank money-printing giving way to high inflation and rising borrowing costs, the markets and types of companies that are better suited to this are unlikely to be the winners of past years. Perhaps it is wise to take a fresh look. 

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Sources

[1] Forget the US inflation shocker – UK labour market data are the real horror story, Capital Economics, 20th September 2022

[2] MSCI United Kingdom Index [accessed 31 August 2022]

Important information

This article does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.

The value of an investment, and any income from it, may go down as well as up and you may get back less than you originally invested.

Past performance is not a guide to future performance.