“People who bet against Britain are going to lose their shirts.”
This warning to the world was issued on the steps of Number 10 by the new British prime minister, neatly summing up what investors have termed the “Boris Johnson trade”.
After Mr Johnson was swept into Downing Street on a promise of “deal or no deal” by the October 31 Brexit deadline, investors anticipate a binary outcome for UK equities.
Do domestic-facing stocks still have further to fall given the increasing fears of a no-deal Brexit? Or despite his tiny parliamentary majority, could the PM surprise on the upside and strike a deal, prompting a rapid repricing of some of the market’s most unloved sectors?
This question is just one of many that investors were pondering as Boris Johnson assembled his new cabinet — including new chancellor Sajid Javid — while watching for signals of policy shifts that could affect our personal finances and the property market.
Binary options for investors
The hardened negotiating stance of the new administration has raised expectations of a no-deal Brexit, causing sterling to sink 2 per cent against the dollar in July amid renewed warnings of recession. This negative sentiment has weighed on UK shares with domestic exposure, but has boosted internationally focused companies whose overseas earnings translate into higher sterling dividends.
There are plenty of investors prepared to “bet against Britain” by taking short positions on UK housebuilders, retailers and domestic lenders proving a particular target. But if Mr Johnson is able to deliver on his promise, these stocks would rebound.
As the FT’s Lex column noted this week, valued against forward earnings, UK equities are currently more than a tenth lower than European markets, and offer a considerably higher dividend yield of around 4.6 per cent.
“Sterling will be the judge and jury,” says Richard Buxton, head of UK equities at Merian Global Investors. “If there is a real sense over the next three months that we’re heading for no deal, sadly, although we’re cheap already, we will go cheaper.
“If [Mr Johnson] manages to pull off a deal, then I can see sterling going straight back to $1.40 and a marvellous rally in the ‘Brexit basket’ of stocks.”
Mr Buxton says that investors including private equity funds already see “lots of opportunity” in UK stocks.
“Just look at the number of UK companies being taken private,” he says, noting this week’s acquisition of Cobham, the defence group, by US buyout fund Advent. The Lego-backed takeover of Merlin Entertainments and Coca-Cola’s acquisition of Costa Coffee are two other recent deals he points to.
“The stock market is so myopic, it doesn’t value long-term earnings streams correctly. We are clearly cheaper than all the other developed markets, but we just need clarity that we’re not going to have a disastrous no-deal scenario and more money will come flowing back in.”
Russ Mould, investment director at AJ Bell, agrees that UK stocks do not look expensive on an earnings basis, and offer attractive yields.
“The risk is that dividend cuts — Vodafone, Marks and Spencer, and perhaps BT, Centrica and GlaxoSmithKline are creeping towards one — take the edge off that angle. But looking at fund flows, the UK is unloved, has underperformed and could be cheap,” he says.
Early hints of future policy direction could be good news for listed housebuilders and estate agents, he says, plus any whiff of tax cuts could boost unloved consumer-facing stocks such as travel and leisure firms and retailers that offer “a decent online presence to supplement their brick-based operations”.
“If those who are less well-off do get some additional relief from a higher national insurance threshold, you would expect that money to be spent to the benefit of firms that address this demographic, such as pubs, casual dining groups and value retailers. It might also soothe concerns about alternative credit providers like Provident, S&U, NSF and Morses Club.”
Even so, Mr Mould cautions that the level of uncertainty leaves investors unable to make a “genuine, rational analysis of what could be involved, what could happen to corporate earnings and therefore what is already reflected in valuations. Until then, investors are just guessing — and guessing is not an investment strategy.”
Other experts argue that investors should ignore short-term volatility and take a much longer-term view.
“People naturally assume that you need to be ‘doing stuff’ ahead of Brexit, but the average investor with a balanced portfolio should resist the urge to meddle,” says Guy Foster, head of research at wealth manager Brewin Dolphin.
“On balance, many portfolios are going to be naturally short on sterling, which will help in an adverse Brexit scenario. The biggest UK stocks are international companies, which will do well from an earnings translation point of view, and bonds will also do well,” he says, noting the record yields on 10-year UK gilts seen this week.
The “Brexit basket” would be the losers — but he argues this presents long-term investors with an opportunity to invest in great companies cheaply.
“We would rather react to the news, than try to position ahead,” he says.
This “wait and see” strategy appears to be supported by data from investment platforms about the relatively high level of cash investors are currently holding.
“Our customers, to date, are holding their nerve,” says Moira O’Neill, head of personal finance at Interactive Investor, an investment platform.
Cash holdings within Isa accounts are currently at 12 per cent, up from 11 per cent at the end of the 2017-18 tax year, the company says. Individual direct equity exposure is falling slightly, from 49 per cent at the end of the tax year to 45 per cent at the end of July as the platform’s investors move towards funds.
“Passive funds saw a big upsurge in June, suggesting investors are feeling less inclined to take big bets on individual managers,” she adds.
Nevertheless, Ms O’Neill stresses this summer is the time for DIY investors to review their portfolios and assess whether they are comfortable with their level of exposure to the UK and smaller companies in particular.
“Even if you have a few so-called ‘global’ funds, it’s worth taking a look under the bonnet, because you might find you have more UK exposure than you bargained for,” she says. The proportion can range from 3 per cent to 49 per cent across “global” investment trusts.
Although some investors may feel UK stocks are cheap, Ms O’Neill notes that the average discount on investment trusts focused on the UK smaller companies sector has “barely budged” since the end of 2018, and remains at about 9 per cent.
“The discount on trusts in the UK All Companies sector has actually narrowed by three percentage points over the past six months, and is also at 9 per cent.”
Other money managers offer a more international perspective.
“Believe it or not, there are bigger things in the world than Brexit,” says Stuart Dunbar, partner at Baillie Gifford. “What attracts us to the majority of businesses we invest in are the global growth opportunities, wherever the companies may be listed. We’re far more interested in what’s going on in the west coast of America and the east coast of China than fixating on European politics. Investors shouldn’t be so insular in their thinking — good companies will prevail.”
Tax and spending pledges
The future direction for taxation and spending policies under new chancellor Sajid Javid — a former City banker — is likely to diverge from the cautious stance of his predecessor.
“You already get the feeling that he will be keen to spend Philip Hammond’s Brexit budget buffer, partly because he feels Brexit will work out for the best and a rainy-day fund is not needed, and partly because he senses the electorate is exhausted with austerity,” notes AJ Bell’s Mr Mould.
Mr Johnson’s speech on the steps of Downing Street this week suggested he would spend, spend, spend, promising more money to “fix” social care and fund public services. Yet he is equally keen to cut taxes.
During the leadership contest, Mr Johnson proposed raising the higher rate income tax threshold from £50,000 to £80,000. According to estimates by the Institute for Fiscal Studies (IFS), this would deliver a £9bn tax boost to 4m people and benefit the top 10 per cent of earners to the tune of almost £2,500 a year.
Mr Javid also raised the possibility of tax cuts for the very highest earners on the campaign trail. While he offered no specific pledges, he noted that cutting the additional rate of tax from 50p to 45p in 2013 led to increased tax revenues.
Yet Mr Johnson also hinted that national insurance thresholds could also be revisited. Currently, those who earn less than £8,632 pay nothing. A rate of 12 per cent applies to the band of earnings up to £50,000 and drops to 2 per cent above this.
Tom Selby, senior analyst at AJ Bell, suspects that any income tax cuts would be tempered by a rise in NI thresholds for higher earners, noting that Mr Johnson “signalled his intention to increase the point at which NI payments kick in to boost lower earners”.
The IFS estimates that every £1,000 increase above the £8,632 primary threshold would cost the Treasury £3bn.
“Taken together, we are talking about a package of reforms costing up to £20bn at a time when a potentially damaging no deal Brexit appears to be looming ever larger,” Mr Selby adds.
Jon Greer, head of retirement policy at Quilter, points out that increasing tax thresholds would have unintended consequences. Pensions tax relief, which already disproportionately benefits higher earners, would become even more polarising.
It could also mean more people qualify for means-tested benefits such as childcare vouchers (currently, a basic rate taxpayer can claim £243 per month while a higher rate payer can access £124 and an additional rate payer only £110).
One of Mr Javid’s more controversial policy ideas was aired in September 2018 when he proposed scrapping auto-enrolment into workplace pensions in the event of a no deal Brexit — comments that have rattled pension experts.
They are also calling on the new administration to scrap the tapered annual pension contributions allowance, noting how Mr Johnson has promised to find a fix for high-earning NHS staff who are refusing to take on extra shifts to avoid tax charges.
Others predict that a new deal for funding social care will be a much higher priority for the chancellor.
“For many, the key assurance they want is that under new rules they won’t have to sell the family home to pay for social care,” says Steven Cameron, pensions director at Aegon. “Our ageing population deserves clarity on what the state will pay for and what individuals will have to fund themselves, based on their wealth.”
What next for property?
There can be no question that Brexit-related uncertainty has weighed on the property market, particularly in London and the Southeast, where transaction levels and average prices have fallen.
Stamp duty has emerged as a potential area for reform under a Johnson government, after he was reported to be considering scrapping the tax on home purchases valued at less than £500,000 to boost the UK’s flagging property market.
The tax is currently paid on property purchases in England and Northern Ireland above £125,000 (or above £300,000 for first-time buyers) and is applied at different rates according to the portion of value above these thresholds.
For instance, it is charged at 2 per cent on the portion of value above £125,000 and up to £250,000; and 5 per cent on the portion over £250,000 and up to £925,000. The highest rate of 12 per cent is charged on the part of the purchase value that lies above £1.5m.
Since 2016, a further three percentage point surcharge has been added for those buying a second home or buy-to-let property in England, Wales and Northern Ireland. Scotland applies its own land and buildings transaction tax on property purchases above £145,000.
Estate agents and mortgage brokers have blamed stamp duty for gumming up the market by imposing high transaction costs on purchasers and discouraging people from moving home.
Other ideas speculated about, but not confirmed, include cutting stamp duty rates at the top end, and flipping responsibility for paying the duty from the buyer to the seller.
In the absence of any concrete proposals from Mr Johnson’s team, experts already warn that such reforms could exacerbate the problem in the short term.
Paul Smith, chief executive of estate agent Haart, said the new government needed to move quickly with any changes. “While Boris’s proposals for stamp duty will come as welcome news for many, we could see transactions slow in the aftermath of his victory as buyers halt activity until the policy introduction. In the long term, I would expect to see buyer interest increase.”
Another consideration for Mr Javid is the cost of any reforms — the IFS found stamp duty land tax raised £3.8bn from housing transactions below £500,000 in 2017-18, although it said the number can fluctuate sharply depending on housing market activity.
Stuart Adam, senior research economist at the IFS, says the costs are likely to be higher than £3.8bn as sellers would be tempted to drop the asking price of properties just above the £500,000 threshold so that buyers could escape the tax.
Away from the tax on property sales, market commentators are already speculating about which electorally pleasing housing policies Mr Johnson (along with new housing secretary Robert Jenrick and housing minister Esther McVey) could yet come up with.
Speaking to the Conservative party faithful on Tuesday, Mr Johnson described home ownership as a “noble instinct”, echoing Tory leaders who have long paid homage to the aspiration of owner-occupation.
So far, there has been no mention of extending the previous government’s Help to Buy scheme, which will be restricted from 2021 and formally ends in 2023. But it is widely acknowledged that the prime minister will need to adopt a broader strategy on UK housing if he is to increase rates of housebuilding and tackle other market pressures, including the high costs of renting a home.
“In an age of mortgage regulation, when the private landlord is under the cosh and you still need to increase supply to private sector tenants, it will be important that he has a much wider approach to housing than just the promise of home ownership,” says Lucian Cook, director of residential research at estate agent Savills.
Under Theresa May, new housing completions in the public and private sector ran at an average of just under 200,000 a year. This compares well with the annual average under the previous four prime ministers in spite of sluggish conditions in the housing market. However, much of the recent growth has been fuelled by Help to Buy.
Mr Cook adds: “The loss of Help to Buy won’t be an immediate concern for Mr Johnson, but it will be a longer term issue he’s going to want to grapple with.”
Addressing the House of Commons on Thursday, Mr Johnson revealed policy ambitions far beyond Brexit, in areas stretching from infrastructure, health and policing to entrepreneurship and business investment.
With a parliamentary majority of just two (including the help of the Democratic Unionist Party) he may yet be forced to temper his aspirations to lead Britain into its next “golden age”. But investors, savers and homeowners will be watching the journey with close interest.