2 August 2018
“The global growth slowdown is most obvious in China and in emerging economies where stresses are beginning to become very visible. For example, the fall in emerging economy currencies and in particular, the weakness of the Renminbi, are the clearest guide to economic stress.”
– Neil Woodford
The UK equity market continued to make positive overall progress in the month of July, despite growing evidence that the economic backdrop is becoming increasingly challenging. The global economy is slowing, most obviously in China, emerging economies and continental Europe. The US is clearly benefiting from the Trump tax cuts but policy error looms in the second half of 2018. The UK economy, meanwhile, continues to confound consensus. Growth here is accelerating and, contrary to much of the rest of the world, the UK’s economic fundamentals are improving.
The Bigger picture
Disappointing French GDP data this morning with just 0.2% growth in Q2. A few months ago, the French economy was deemed to be “flying”, while the UK was seen as the global growth laggard. Now, UK growth forecasts exceed those of France – market behaviour continues to ignore this.— Woodford (@woodfordfunds) 27 July 2018
An excellent @martinwolf_ @FT piece exploring the history & scale of China’s massive debt burden. Tariff tensions have grabbed the headlines but are a sideshow compared to the implications of China’s slowdown for commodities & many parts of global markets.https://t.co/HKcJyGRVUg— Woodford (@woodfordfunds) 25 July 2018
Key Company Events
Clients often ask, if we are right on China, why does this have any relevance to the Woodford funds and, in particular, the significant exposure to the UK economy?
China’s economic outcomes will have an effect on the UK economy, but this is likely to be muted. Where China’s economic performance will be felt more dramatically, of course, is in the businesses that interact with what China buys and sells and those that have invested in the economy directly. This is, of course, therefore very relevant to some of the UK’s largest businesses (index constituents) in the oil, mining, luxury goods and financial services sectors.
It is worth reiterating here, that the UK economy and the UK stock market are two very different beasts. There are 2.5m non-financial companies in the UK – just 1% of them are foreign-owned. Companies in the FTSE 100 employ just 3m people in the UK out of a workforce of 33m. As a result, although China’s influence on the UK economy is relatively small, it’s influence on the UK stock market, is profound.
So, China is most relevant to what we don’t own in the portfolios. Clearly, all of this is more pertinent to the performance of the funds from a relative perspective. However, there is an important characteristic of momentum-driven pricing in asset markets, which is that, whilst the crowd rushes towards a part of the market that everyone wants to own, they are always deserting another.
Given this yin and yang nature of momentum-driven market inefficiency, there is an absolute perspective too – it creates valuation opportunities for active fund managers to exploit. In the current environment, this explains the valuation opportunity in UK-exposed businesses, which the funds are positioned to exploit.