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The view from the ground: UK business still on track

By Phil Harris, manager of the UK Equity Growth Fund
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Turmoil in UK Equity Markets

The past 18 months have been a particularly turbulent time for the UK economy. After Britain's vote to leave the European Union there was an inevitable spike in volatility and sharp falls for Sterling. Longer term, many are concerned about the potentially irreversible negative effect that 'Brexit' might have on UK business. 

Initially these worries were not recognised, as consumer spending remained strong and the UK economy grew by 2% in the year to Q1 2017. However since then, it is safe to say we have not done as well as hoped, with some forecasts downgraded and continued political upheaval both making their impact felt in UK equity markets. In the face of this uncertainty, consumer spending has slowed. 

Not All Doom and Gloom

What is clear however, is that when you are out and about talking to companies, meeting them face to face and seeing their operations - which for the UK Equity Growth Fund forms a core part of how we find investments that are going to add alpha - confidence is not lacking. Whilst many Chief Executives might struggle to answer the question of what Brexit means for them and bemoan the lack of clarity in the future, when questioned on how they are adapting their business now in preparation - cutting capital expenditure for example - I have often found that Chief Executives are actually happy at the strength with which their businesses are performing and are confident in how things look going forward. 

So despite both consumers and investors showing signs of uncertainty, in the background there seems to be minimal disruption to UK business. There has been a slowdown, with the effects of inflation starting to cause a slight drag, but moving forward there is a generally positive outlook for the next year with many expecting a positive turnaround. 

Positive Global Backdrop

A core part of this confidence comes from the fact that a large percentage of earnings for these sorts of UK PLC's come from overseas - typically between 60-70%. So when you talk to Chief Executives, they are not just looking at what is going on in the UK but they are thinking globally. The wider European economy is looking very strong, the US remains solid and Asia looks poised for continued growth. Having an international outlook helps protect against troubles in the UK market - overall there are low interest rates, low inflation and a generally positive economic backdrop internationally, and this is helping UK businesses ride out any waves of uncertainty that they are facing domestically. 

Changing Patterns in Consumer Spending

Looking back towards the UK, it is important to recognise the power of consumer spending within the UK economy and the potential problems this causes if consumer confidence takes a knock over Brexit. 

From an investment perspective however, I am finding that is is not necessarily a case of 'if' consumers are spending, but 'how'. Despite unemployment rates being at historic lows, wage growth in the UK is actually faltering. If you are in a job, you are perhaps typically seeing around 2% wage growth annually, but inflation is nearer to 3% meaning that the spending power of your pound is being tested. 

What this looks like then, in terms of consumer behavior, is that people spend less on big ticket items such as cars or furniture, and switch their focus to the little luxuries in life - going out for coffee, or ordering a takeaway. Consumers are allocating their pound rationally into the things that they can afford which improve their quality of life, and are deferring on other larger spends that can wait for better times. 

An Investment Proposition

It is important to consider how all of this feeds into an investment strategy for UK equities. To begin with, exposure to large-caps with strong international earnings is a good way to acheive some stability. 

Looking towards domestically focussed companies, which in the current environment are perhaps more risky, the most important thing to recognise is how the underlying currents of economic and corresponding social change are playing out on various sectors and adjust holdings accordingly. 

For example in the current climate, the UK Equity Growth Fund is avoiding stocks such as motor retailers, because a car is a big-ticket item and consumers are shying away from these. However, a long-term holding which we recently added to was Patisserie Valerie, the luxury patisserie chain. Another recent purchase was in Domino's Pizza, the takeaway chain. Both of these deal in the 'little luxuries' mentioned earlier, and recent performance has been strong as that shift in consumer spending habits starts to play out. 

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