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Richard Buxton: What to expect from markets after the summer holidays

There are clues that can be gleaned about the prospects for the UK economy and equity sectors throughout this coming autumn term

Buxton Richard Old MutualAs the office begins to fill again with colleagues returning from their summer holidays, we enter the final third of the year that will always be associated with a sense of going back to school after summer.

A period bereft of bank holidays, we know as we head into September that the days will be getting shorter until, yet again, you only see your house in daylight at the weekends.

A period often associated with market dislocations, together with profit warnings from those companies that claimed growth would be “second half weighted”, what clues can we glean about the prospects for the autumn term?

The world is not in bad shape. The US economy continues to chug along, neither so fast as to encourage swifter interest rate increases by the Federal Reserve, nor so slow as to raise fears of the post-crisis expansion coming to an end.

China maintains its policy of alternately pressing ever so gently on the accelerator, then the brake, accelerator, brake, thereby staying on the path of steady growth. And Europe, for all those start-of-year fears of political upheaval, has at last begun to see an economic recovery that looks self-sustaining, with a credit pulse and falling unemployment.

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In the UK, while growth has been slower in the first half of the year than in the second half of 2016, there are reasons why this deceleration is unlikely to worsen and activity can stay positive. Employment continues to grow.

Given over 700,000 job vacancies, the numbers of people employed will continue to set new records. What has been missing, of course, is wage growth. Pin it on the demise of union power, more self-employed or part-time workers, immigration expanding the workforce or “the wrong kinds of jobs” but wages have remained subdued.

As sterling’s fall led to the inevitable pick-up in inflation, real wages have been squeezed, which has been reflected in a deterioration in measures of consumer confidence. It is here that things may well be close to a turning point: if inflation is near peak and begins to fade, real wages may start to expand again, supporting consumer spending.

Against this, it is likely the slowdown in house price growth seen in London in recent months will spread  more widely. While no bad thing in itself, transaction volumes remain way below longer-term averages. People appear trapped, whether looking to downsize or up-scale, by the lack of available stock on the market.

Perhaps the Chancellor could use his first new Autumn Budget to reduce stamp duty or introduce other measures to stimulate turnover in the housing market, which would boost economic activity.

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In reality, though, it is likely the Government will want to keep such limited fiscal powder as it can muster dry until 2019 – after Brexit. Given the uncertainties associated with the post-March 2019 world, it would be wise to retain the maximum flexibility to provide some stimulus through Government spending until then.

Simply relaxing the 1 per cent pay restraint on public sector workers would be an easy way to put some juice into consumption, should activity suffer post-Brexit. So those hoping for excitement – or a pay rise – from this Autumn’s Budget may well be disappointed.

The half-year results season reflected the state of the world. Profits grew in most cases and the tone of commentary from the boardroom was positive, though mindful of the potential headwinds visible. Companies are not waiting for a lead from governments but getting on with life.

Things are tough in retail, where the rise in online competition is exacerbating the impact of a cautious consumer. Travel and leisure is faring better, though it is competitive and sadly impacted in the case of city leisure travel by high profile terrorist incidents.

Among engineering and industrial companies, the mood music feels better, with real signs of rising order books for many and the worst effects of the downturn in oil and mining sectors now well past.

The oil price itself appears becalmed, while the oil majors fight to reduce costs, lower break-even prices and maintain dividends. Mining companies are through their phase of balance sheet repair and enjoying strong cash-flows from rejuvenated commodity prices.

They are sufficiently scarred by the recent downturn as to stick to their cautious mantra on new cap-ex and projects, so for now shareholders will reap the benefits in dividends and share buybacks.

All in all, the macro backdrop  is okay and corporates are in reasonable shape. The problem? Equity markets have done well and valuations reflect much of this good news.

Encouragingly, investors are cautious, cash levels are high and many would welcome a market correction to add to holdings. I felt at the start of the year that returns may be front-end loaded in 2017, so with valuations rich it would be no surprise if markets provide some interesting buying opportunities through the autumn term.

Richard Buxton is head of UK equities at Old Mutual Global Investors


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