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Neil Woodford: The state of the Union

Neil Woodford Peach

For all the talk of hung parliaments, horse trading and coalitions, the result of the general election came as a surprise to many – including us. The polls had consistently predicted a close result and so very few commentators (probably none) had expected such a strong performance from the Conservatives on the night.

A Conservative majority is a better outcome than I had feared. That is not a party political comment but a view that is based on the fact such a decisive result removes the risk of the prolonged period of political uncertainty I had been worrying about and which would clearly have been bad for the economy.

It does not, however, remove all of the political uncertainty. The performance of the Scottish National Party gives them a significant voice in parliament but no power. Question marks remain, therefore, about the viability of our constitution and the Union. Can David Cameron hold the United Kingdom together? What’s more, is it fair that our political system can deliver an outcome in which the number of seats in Westminster deviates dramatically from a party’s share of the national vote?

These domestic issues are important and the answers to them could have profound social and economic consequences. But there are also wider issues involving another union: the election result heralds a referendum on Britain’s membership of the EU by 2017. Cameron’s attempts to renegotiate Britain’s relationship with Europe will shape that debate but, at the moment, we are neither fully in nor fully out of the European project.

This position looks increasingly unsustainable but both of the available options have significant shortcomings and risks. Indeed, the level of uncertainty that exists around Britain’s relationship with Europe may already be manifesting itself macroeconomically by making international businesses less inclined to invest in the UK.

The eurozone itself continues to face major challenges. If the single currency is to succeed, it requires fiscal and political integration to sit alongside monetary union. Although Europe’s political elite is keen to pursue this agenda, their mandate to do so is gradually being diminished by disillusioned electorates that appear keener to explore alternatives. There are nationalist movements all over Europe, not just in Britain.

Meanwhile, in Greece, Syriza was elected with a mandate to end years of painful austerity but talks with its creditors have not gone well thus far. The simple fact remains that Greece’s debt burden is unsustainable. It cannot afford to pay. As the saying goes: “That which is unsustainable will not be sustained”. Ultimately, it is inevitable that Greece will have to default. It is no longer a question of if but a question of when. How this default is managed and whether Greece leaves or stays in the eurozone will have profound implications – not just for Greece but for the rest of the eurozone.

Sometimes, grappling with the big macroeconomic issues of the day and fully understanding their implications can be difficult. But all companies operate in the real economy and are influenced – some more than others – by these factors. It is critical, therefore, that we are mindful of potential macroeconomic consequences and invest accordingly. Perhaps it is a matter of time horizons but often the market appears very complacent about these things. The risks are often dismissed as too distant or too improbable to worry about.

As a long-term investor, however, it is my job to worry about them. It is my job to try to deliver an appropriate long-term risk-adjusted return to our clients. If I ignore the risks, how can I ever hope to achieve that? I would only be looking at one side of the coin.

Nevertheless, in weighing up the risks and the rewards, I remain optimistic. Equity markets may be somewhat complacent right now but, although there is clearly a lot of risk in certain parts of the market, there are also areas where valuations remain compelling. The state of the union is uncertain but our confidence is undiminished.

Neil Woodford is head of investment at Woodford Investment Management

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There is one comment at the moment, we would love to hear your opinion too.

  1. There is clearly a lot of uncertainty regarding Britain’s relationship with Europe and there is a massive problem, for Europe, with the Euro.
    There are a number of stages that will have to be gone through as far as Britain is concerned. Obviously David Cameron’s team will have to do their best at the negotiation table and then come back with a recommendation ‘IN’ or ‘OUT’.
    If the electorate should decide to leave the EU then further negotiations will have to take place about how this would happen and what ongoing relationship Britain will then have going forward.
    Doom and gloom has been the response of the Europhiles, but is this right? There are other countries that have trading relationships with the EU which seem to be very successful. Their economies are much smaller than the UK’s so I would expect us to be in a very strong position to get very favourable terms. We have not seen this even explored in the media let alone discussed. There is a vey long way to go yet.

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