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Neil Woodford: UK will be 2018’s surprise success story

The volatile start to the year may well have represented a turning point in market conditions.

I said at the start of this year that I believed the market consensus had misread the outlook for the UK economy, where fundamentals are improving, not deteriorating. The data so far in 2018 appears to support this.

Chancellor Philip Hammond’s Spring Statement earlier this month was accompanied by an upbeat assessment of the UK’s economic situation. At the same time, however, despite acknowledging some better recent economic data, the Office for Budget Responsibility has remained more circumspect about future UK growth prospects, primarily because of continued productivity concerns.

So, who is right? Our upbeat Chancellor or the downbeat OBR?

My view chimes much more resonantly with that of Hammond, and it is a view supported by hard evidence. Manufacturing is growing more strongly, the labour market is setting records, inflation is falling and, as a result, we have just seen a return to real wage growth in the UK for the first time since early 2017.

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With inflation expected to moderate even further and the prospects for wage growth improving, I am confident the extent of UK real wage growth will become more meaningful as the year progresses, with the obvious positive ramifications for household finances and the economy more broadly. Overall, there are plenty of positives in the UK right now, which are not receiving as much media or market attention as they deserve.

Interestingly, the global economic picture has started to look a little less rosy, with data disappointments emanating from the US and Europe, alongside growing concerns about the impact of tighter US monetary policy on other parts of the world such as Asia.

In fact, there is an increasing possibility that the UK economy could be the fastest growing of all OECD nations by the end of 2018.

This would come as something of a surprise to a global market consensus that has become institutionally negative on the UK’s growth prospects (according to the Bank of America Merrill Lynch Global Fund Manager Survey, asset allocators have rarely been as substantially underweight UK assets as they are now), while at the same time implying an increasingly complacent view about global growth.

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Little wonder, then, that financial markets have seen a volatile start to 2018. Many of the assumptions upon which equity markets have been relying are being slowly undermined and I expect that to continue.

At times like this, one might expect investors to revisit areas that have been out-of-favour, as they search for undervalued assets capable of weathering volatile conditions more successfully. The UK is home to many such assets and, in the aftermath of the market declines we saw in early February, the environment has started to feel somewhat different to the conditions that had prevailed for much of the prior two years.

The valuation stretch in markets has not meaningfully moderated yet but the momentum in certain parts of the market has, inevitably, been called into question.

We may be in the foothills of a profoundly different market environment

Meanwhile, global corporates seem to have become more attuned to the valuation opportunities that now exist within the UK stockmarket. In recent weeks, we have seen bids for Fenner, Fidessa, Hammerson and Laird from overseas companies apparently keen to snap up the bargains on offer.

This flurry of deal activity is representative of the widespread undervaluation that results from the unpopularity of UK equities among global institutional investors. In turn, it may also represent something of a precursor to a re-appraisal of the UK economy’s prospects and the stocks exposed to it.

Although it remains too early to suggest that the volatile start to 2018 represents a definitive turning point in market conditions, things are playing out broadly the way I have anticipated from a macro perspective. We may now be in the foothills of a profoundly different market environment. Fundamentals have not mattered recently but they should start to do so more from here.

Neil Woodford is head of investment at Woodford Investment Management

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