UK: On your marks, get set … spend?
James Moir (Equities Analyst, UK Growth) looks at the UK’s path to recovery, discussing the income disparity between households and whether consumers’ excess savings are more likely to be spent or stay saved.
A year ago the UK was in the teeth of its first wave of Covid-19, but the very strong vaccine rollout so far in 2021 gives reason for optimism. Broadly, this has had the expected – and hoped for – impact on the domestic UK economy, as consumers look to spend more in total, as well as to modestly rotate their spending patterns as lockdown restrictions unwind.
In March, in particular, we saw a step change in data, with retail sales up 5.4% in the month; the composite PMI reaching its highest levels since 2013; a second-consecutive monthly fall in unemployment; and a 16% increase in job vacancies. The retail sales beat was driven in part by strong performance from clothing and garden supplies, as consumers prepared to meet friends and family again. Reassuringly, retail sales in March 2021 were ahead of those in February 2020, the last month before lockdown began.
While this recovery was generally expected, we were still encouraged to see the strong data coming through, especially as the UK recovery has been advancing faster than consensus given a potentially volatile recovery pathway. There remain significant questions for the UK over the longer term, though. What happens once the furlough scheme ends? How will the government manage its debt position in the long term? To what extent can we expect to see a significant tailwind to expenditure from accrued savings as lockdowns unwind?
The OBR (Office of Budget Responsibility) estimates that UK households will have accumulated almost £180bn in excess savings, or approximately 8% of GDP, by mid-2021. However, recent research has flagged the significant disparity between households based on income: savings having been accrued largely by the wealthiest households, while those on the lowest incomes have been spending more than they earned, as their incomes fell and costs rose. Given different propensities to consume, this will have a significant impact on where demand emerges and on inflation. We’ve already seen significant inflows into longer-term savings platforms used by the more affluent, as well as net paydowns of consumer debt, potentially suggesting that more of these savings will remain saved.
In terms of UK equities, the market appears to have pre-empted quite a lot of this strong macroeconomic data. In aggregate, the UK market is up around 8% year to date, but with a very significant factor rotation: value outperformed growth by around 400bps from January to the end of March, but growth then outperformed by approximately the same amount in April, with a switch in focus to long-term uncertainty.
Now, the market seems to be moving away from the value vs growth debate, instead asking more nuanced questions: is there still some cyclical bounce to come? Which sectors will be slowest to recover from Covid? Which companies will emerge in a better market position with improved growth opportunities post Covid? And is the recovery already priced in, given strong performance in cyclicals and recovery plays since November?
In terms of company results, the first-quarter earnings season has only just begun in the UK, and results to come may shed more light. So far, we’ve seen some indication from industrials that there might still be some room for some cyclical companies to outperform market expectations, but on the other hand, some sectors seem to suggest a longer road to recovery. Likewise, whilst it’s still early to see material improvements in the long-term opportunity, and the pathway to stronger market positioning could be bumpy for some as we recover from Covid, we are already seeing encouraging signs that for some companies the post-Covid opportunity could be bigger and market structures could be more appealing.
Record issuance in convertibles – but where’s the coupon?
Lee Manzi (Fund Manager, Multi-Asset) discussed trends in the global convertibles market, including a record level of issuance so far this year.
There is a tendency for equity investors to be frustrated, understandably, when companies issue convertible bonds, as share prices often fall as a result. The appeal of convertibles for issuers, however, include ability to issue equity at a premium to the current share price, monetizing their stock volatility, greater financial flexibility and lower coupon costs than a bond issue.
We have seen a record start to the year for convertibles issuance, with $75bn to date, which is almost on a par with the annual issuance seen in recent years. This comes after a strong 2020. The activity this year has been led by the US companies, with two-thirds of all issuance, although there has been much more of a mix of companies coming to market. Consumer discretionary has taken over from tech as the largest sector., while last month’s $3bn issue by a Chinese company was the largest ever Asian convertible raise.
The average equity premium is 40% against a long-term average of 30%, and the average coupon is 1% against the long-term average of 2%. That is not surprising to me, given where nominal yields have been, but just over half of the new issues are offering 0% coupon. The combination of record high premiums and record low coupons explains why it has been such a strong start to the year.
There has been a material cheapening in the secondary market and some remarkable terms for some issues. For examples, a quasi-tech company raised $1bn on a 65% premium and 0% coupon recently, and that issue is now trading at 120% premium.
We see several interesting themes at the moment, including the reopening of the economy and the implications that has in particular for airlines and retail. Also interesting to us are semiconductors, digital payments, cyber security and emerging market consumer plays.
We are slightly nervous about equity and credit valuations given the rallies that we have seen and some of the sentiment indicators look vulnerable. We prefer Asia and Europe over the US from a relative perspective.
Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.