Improving UK economic fundamentals

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We believe that the market consensus has misread the outlook for the UK, where economic fundamentals are improving, not deteriorating. Looking forward, we see UK economic health improving, with more people in work, more wage growth, less inflation, more investment spending, better public finances and a continued recovery in manufacturing and exports.

We believe the UK economy is capable of continuing to grow by annual rate of 2% or more, irrespective of the outcome of the Brexit negotiations. This is a considerably better outcome than the recession that some of the more pessimistic commentators are forecasting and what is clearly priced in to equity market valuations. It will also compare very favourably with most other major economies, many of which are rapidly losing momentum amid increased political risks and tighter monetary policy.

Overall, the data we’ve seen this year points to a strong labour market, real wage growth and a strong banking system. In April, real wage growth re-emerged as the post-referendum inflation, which was caused primarily by the decline in sterling, started to moderate – we expect this to continue going forward. Meanwhile, according to ONS data released in June, the unemployment rate is the lowest since 1975, and, with more than 800,000 job vacancies waiting to be filled, we think the UK economy will benefit from further employment growth.

Meanwhile, the UK has a healthy banking system that is very well placed to continue to provide growth-enabling credit to businesses and consumers. This, coupled with all the other positive trends in the domestic economy that we are seeing and the disappointing data elsewhere, leads us to believe that the UK may exit 2018 as one of the fastest growing OECD economies.

Authers’ Note: Buy Europe. And Buy the UK. Really.

14 March, 2018 John Authers

FT Logo

Authers’ Note: Buy Europe. And Buy the UK. Really.

Here we go again. I am going to suggest that it might be time to buy European equities. And in particular, it might even be time to buy equities from the UK (which is still politically part of the EU).

I have made this argument on a number of occasions in the past, and it has not always worked well. European equities have looked cheap relative to US equities for years now, but there has been good reason for that. But last year you would, contrary to many perceptions, have made more money in European stock markets than in the US. And the moves of the past few weeks have again made Europe look attractive.

To start, here is the gap between the price-to-book multiples on US and European stocks, and how they have changed over time:

There are reasons why the US stock market is more expensive than its European counterpart, but they can mostly be condensed into one syllable: tech. The US has Silicon Valley and the Fang stocks, and Europe does not. Many large US tech stocks are still going through a period of secular growth, so it is natural that the US as a whole should sell at a premium. But why has the premium widened significantly since Europe began to emerge from the eurozone sovereign debt crisis five years ago?

Also, it is noticeable that European equity performance has ground to a halt. While the US has enjoyed the Trump bull market (fuelled in large part by the weak dollar), European equities have suffered from the strong euro, and have been hit harder by the recent volatility:

This is strange because ISM supply manager surveys remain far more positive for Europe than they do for the US. Most tellingly, there is the difference in monetary policy. The US is (very slowly) withdrawing from crisis-era monetary policy. The eurozone, through the European Central Bank, is still buying up assets. As a result the gap between US and German bond yields has widened to a post-eurozone crisis high:

Rising bond yields are widely and probably correctly cited as the key catalyst for the correction in the US. Why then has the correction hit harder in Europe, where stock valuations should benefit from cheap money from the central bank for a while longer?

Politics is one obvious answer. Europe has staged a series of elections that markets found frightening since the US last held a presidential election. But none of the outcomes has been particularly scary. Investors got exactly what they wanted in the Netherlands and (particularly) in France, and Angela Merkel survived in power in Germany. This month’s election in Italy made nobody outside Italy very happy, but it did not come as a great surprise — and in any case, Italian assets have been performing better than most of the rest of the continent. And on top of that, it is not as though the US does not have to deal with some political uncertainty of its own.

All of this suggests that even Europe has been a popular investment for a while, on the grounds of valuation, it might still be an interesting investment. And interest in Europe does appear to be falling a little. European equity allocation is the lowest in almost a year, according to the last BofAML survey of fund managers. The summary of the survey’s findings is as follows:

Global investors’ allocation to European equities dropped to net 41% OW from net 45% last month, the lowest since March ’17. Meanwhile, UK equities have been underweighted for 47 consecutive months. Intentions to own Europe are waning, but this seems more of a "relative" call. Despite improving confidence in European earnings, the US and EM profit cycles are seen as increasingly favourable compared to the European cycle

BofAML suggests that this is largely because hopes for profits in the US (aided by the tax cut) and in Japan have now largely caught up with Europe.

It remains clear that those investing in Europe are still doing so in the hopes of strong earnings growth, with many of them expecting growth in double-digits.

Direct questions of fund managers similarly confirmed that profits growth, plus some signs that the eurozone has sorted itself out and made some important structural reforms, remain the things that investors most want to see. Neither of these is anything like certain, and the prospects for eurozone reform have almost certainly weakened following the results of the Italian election (although they look far, far better than they would have done had Marine Le Pen triumphed in France).

This does lead to one last area of concern, which is that investors do remain overweight in Europe, even if they are steadily moving away from that position.

That leads to the contrarian opportunity of the moment. If you really want to invest in a country that is seriously out of favour, and has been for a long time, try the UK. This is the same exercise carried out for the UK:

Global fund managers have been net underweight in the UK for almost four years now, and dislike for the UK remains almost universal. It is difficult to see how revulsion can proceed much further from here.

Without wanting to revive some of the infuriating arguments about the verdict of the stock market that came up in the first few days after the Brexit referendum, it bears pointing out that as far as the market is concerned the UK stands to lose out terribly compared to the rest of Europe as a result of leaving the EU. As the chart shows, this is true whether you use the FTSE 100 large-cap index, or the smaller companies in the FTSE 250 index.

The chart is in common currency terms and shows a dramatic loss of confidence in the UK, particularly given that this period included lengthy stretches of angst when investors were worried about political risks in France, the Netherlands, Germany and Italy.

Uniform performance from both the FTSE 100 and FTSE 250 is unusual. To demonstrate this, look at the performance of the FTSE 250 compared to the rest of Europe, since the establishment of the euro:

And now compare it with the dreadful performance of the multinationals in the FTSE 100:

The latest nadir comes from the latest economic bulletin from the Chancellor of the UK. As Fiona Cincotta of City Index pointed out:

There was actually little to cheer despite the upbeat presentation from an unusually positive [Philip] Hammond. Whilst an upward revision for 2018 is certainly something to be excited about, let’s not lose track of the fact that this is the first time in modern history that GDP growth is forecast to be below 2% for each year forecast (until 2022). A woeful outlook by historical standards. And this is still subject to Brexit related uncertainties. Regardless of how positive Hammond’s performance, there is no escaping that at a time when the rest of the world is booming, the UK is staring an extended period of weak growth in the face.

Then of course the UK’s attempt to fashion a viable post-Brexit settlement appears to be going terribly, amping up the uncertainty. But it is quite possible that enough bad news is now in the price.

I am a Financial Times columnist, I completely agree with the FT’s editorial line on Brexit, and I voted Remain myself. I would certainly do so again given the chance. But I do wonder whether the negative economic consequences of Brexit for the UK have been exaggerated. One helpful commenter drew my attention to this working paper published by the University of Cambridge entitled "How the Economics Profession Got It Wrong On Brexit". Some early words from the introduction suffice to give a flavour:

Our conclusion is that most estimates of the impact of Brexit in the UK, both short-term and long-term, have exaggerated the degree of potential damage to the UK economy. We stress at this point that this is not a politically-driven exercise. Most of the four-person team behind the research for this and our other papers voted ’Remain’ in the 2016 referendum and would do so again if given the chance. Our purpose is rather to establish a sound basis for the ongoing debate on the likely potential economic impact of Brexit, and more generally to question the quality of economic analysis in dealing with major, macroeconomic policy issue like Brexit.

Many fundamental questions for the future of the UK arise from the Brexit mess, and from the issues in this paper. One of the least important, but most interesting if you are an international investor, is the strong implication that the UK might well by now be a contrarian buying opportunity.

Copyright The Financial Times Limited 2018

© 2018 The Financial Times Ltd. All rights reserved. Please do not copy and paste FT articles and redistribute by email or post to the web.


Neil's view

As we have been anticipating, with inflation moderating and wage growth picking up, we now have real wage growth again in the UK. This should become more meaningful as the year progresses.

View chart
21 March 2018

An upbeat assessment of the UK economic outlook from Chancellor Hammond yesterday. Somewhat surprising therefore, to see the OBR become incrementally more negative, whilst at the same time acknowledging that manufacturing is growing more strongly, inflation is falling, the labour market is setting records, and real wage growth returns to the UK this quarter. I remain positive on the UK economic outlook.

View chart
14 March 2018

In essence, my relatively positive view of the outlook for the UK economy stands in stark contrast to a very bearish market consensus. I’m not expecting rampant growth from the UK economy but 2% GDP growth in 2018 looks eminently achievable. Many commentators are talking about recession and that appears to be reflected in valuations – hence the opportunity.2 January 2018

I’ve rarely witnessed such an overwhelming consensus view — which I believe to be profoundly wrong — that the UK economy is going to hell in a handcart. People have become so extreme in their view that Brexit is a pre-determined disaster for the UK economy, that the share prices are discounting literally economic Armageddon for the UK economy.

Read full article
1 December 2017

In recent months, an increasingly benign view of the UK’s economic prospects combined with the wider market’s antipathy towards domestic cyclical businesses, has created a contrarian opportunity. From our perspective, UK housebuilders and the construction industry more broadly, now look poised to benefit from structurally positive fundamental dynamics and a long-term opportunity which is underpinned by the public sector.

Read full blog
29 June 2017

UK domestic stocks trade on decade low valuations relative to globally-exposed stocks

Source: UBS, Woodford

UK-focused stocks trade on very attractive valuation levels not seen in years. Our funds are positioned to capture this long-term opportunity.

We now have real wage growth in the UK

Source: Lazarus Partnership, Bloomberg, Woodford

OBR forecasts for UK growth have become more negative - we believe this is wrong

Source: Office for Budget Responsibility, Lazarus Research, Woodford

Relationship between global PMI data and FTSE 100 performance has broken down

Source: Datastream, Haver, Goldman Sachs Global Investment Research, Woodford

Sales weighted PMI = global Purchasing Manager’s Index survey data weighted by the geographic sales exposure of the FTSE 100 index.

Pessimism towards UK equities is close to post financial crisis lows

Source: BofA Merrill Lynch Global Fund Manager Survey, Woodford

Net overweight/underweight (100 = 02.18) UK index vs World index performance Fund managers overweight UK (Net %) 16015014013012011010090 403020100-10-20-30-40 98 00 02 04 06 08 10 12 14 16 18 Big short

The UK stock market has underperformed other regional markets since the Brexit vote

Source: Bloomberg, Woodford

Global-facing UK stocks have outperformed domestic-focused UK businesses since Brexit

Source: Bloomberg, Bats Indices, Woodford

The Bats 100 index tracks the top 100 UK listed companies based on market capitalisation. The BATS UK Brexit high / low 50 indices represent the 50 companies in the BATS 100 index which derive the largest / smallest proportion of their revenues from the domestic economy.

UK economy continues to defy expectations of a slowdown

Source: Bloomberg, Woodford

UK domestic stocks trade at a rare valuation discount to UK exporters

Source: Morgan Stanley, Woodford

UK job vacancies at record level

Source: Lazarus Partnership, Woodford

How the funds will benefit

If the UK economy performs better than people think, then by extension, it is logical to expect that some companies which are exposed to the UK economy, will also perform much better than people think. Herein lies an opportunity which we have positioned the funds to exploit. The valuations of many housebuilders, construction businesses and retailers are simply too cheap and growth expectations far too low.

We believe that the share prices of many domestically-focused businesses will stage an impressive recovery from here and the funds are positioned to benefit from this.

LF Woodford Equity Income Fund (as at 30 November 2018)

Geographical allocation
Country Fund (%)
United Kingdom 86.46
United States 12.79
Norway 1.11
Ireland 0.75
Switzerland 0.62
Luxembourg 0.47
Sector allocation
Industry Fund (%) Benchmark (%)
Financials 36.78 25.70
Health Care 23.47 10.32
Consumer Goods 21.39 13.71
Industrials 14.48 10.62
Technology 4.83 0.94
Consumer Services 1.21 11.45
Basic Materials 0.05 7.35
Telecommunications 0.00 3.17
Utilities 0.00 2.76
Oil & Gas 0.00 13.99
Cash and near cash -2.20 0.00
Total 100.00 100.00

We have positioned the fund to capture a contrarian opportunity that has emerged in domestic cyclical companies where valuations are too low and future growth expectations far too modest and therefore, the portfolio has an increased bias towards UK revenues. Back in September 2015, we estimated that 41.9% of the portfolio’s revenues came from the UK. Now that number has risen to 55.5%.

LF Woodford Equity Income Fund's geographical exposure based on underlying revenues

Source: Bloomberg, Woodford (as at 30th September 2018)

What are the risks?

  • The value of investments and any income from them may go down as well as up, so you may get back less than you invested
  • Past performance cannot be relied upon as a guide to future performance
  • The annual management charge applicable to the funds is charged to capital, so the income of the funds may be higher but capital growth may be restricted or capital may be eroded
  • The funds may invest in other transferable securities, money market instruments, warrants, collective investment schemes and deposits
  • The funds may invest in overseas securities and be exposed to currencies other than pound sterling
  • The LF Woodford Income Focus Fund will be invested in a concentrated portfolio of securities – the fund is not restricted by reference to any geographical region, sector or market capitalisation
  • The LF Woodford Equity Income Fund may invest in unquoted securities, which may be less liquid and more difficult to realise than publicly traded securities

Important information

Before investing, you should read the Key Investor Information Document (KIID) for the fund – or Key Information Document (KID) for the trust – and the Prospectus which, along with our terms and conditions, can be obtained from the downloads page or from our registered office. If you have a financial adviser, you should seek their advice before investing. Woodford Investment Management Ltd is not authorised to provide investment advice.

You should note that capital is at risk with these investments and you may get back less than you invested. The value of the fund or trust as well as any income paid will fluctuate which may partly be the result of exchange rate changes.

The price of shares in the Woodford Patient Capital Trust is determined by market supply and demand, and this may be different to the net asset value of the trust.

The Woodford Patient Capital Trust currently intends to conduct its affairs so that its securities can be recommended by IFAs to ordinary retail investors in accordance with the FCA’s rules in relation to non-mainstream investment products and intends to continue to do so for the foreseeable future. The securities are excluded from the FCA’s restrictions which apply to non-mainstream investment products because they are shares in an investment trust.

Young businesses have a different risk profile to mature blue-chip companies – risks are much more stock-specific, which implies a lower correlation with equity markets and the wider economy. Long-term outcomes are more binary – extremely attractive rewards for success but some businesses will inevitably fail to fulfil their potential and this may expose Woodford Patient Capital Trust investors to the risk of capital losses. As it can take years for young businesses to fulfil their potential, this investment requires patience.

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address 9400 Garsington Road, Oxford OX4 2HN.

Woodford Patient Capital Trust plc is incorporated in England and Wales, company number 09405653. Registered as an investment company under section 833 of the Companies Act 2006. Registered address Beaufort House, 51 New North Road, Exeter, EX4 4EP.

The Woodford Funds (Ireland) ICAV (the “Fund”) has appointed as Swiss Representative Oligo Swiss Fund Services SA, Av. Villamont 17, 1005 Lausanne, Switzerland. The Fund’s Swiss paying agent is Neue Helvetische Bank AG. All fund documentation including, Prospectus, Key Investor Information Documents, Instrument of Incorporation and financial reports may be obtained free of charge from the Swiss Representative in Lausanne. The place of performance and jurisdiction for all shares distributed in or from Switzerland is at the registered office of the Swiss Representative. Fund prices can be found at

© 2019 Woodford Investment Management Ltd.
All rights reserved.

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