By Jason Hollands


This week has seen a raft of new measures from the UK Government culminating in Chancellor Kwasi Kwarteng’s eyebrow-raising mini budget yesterday. Among the myriad of announcements were details of the energy support package for businesses.

The new Chancellor also made good on Liz Truss’s pledges to lower taxes. The 1.25 per cent rise in National Insurance implemented earlier in the year will be reversed from November, and plans to raise the main rate of corporation tax from 19% to 25% next April have been scrapped.

Mr Kwarteng also announced the creation of “investment zones” that will have both tax perks and liberalised planning regulations. Together this was the biggest roll of the dice on tax cuts in at least 30 years.

The Chancellor is targeting a GDP growth rate of 2.5% a year – a level not seen since 2006. Back then there were helpful tailwinds with an expanding labour force, but recent data shows that while unemployment is low, some 154,000 people left the workforce in the three months to July, with many people having already taken early retirement during the Covid pandemic. A shrinking workforce constrains growth, making a 2.5% target challenging.

From an investment perspective, fiscal expansion of this scale is bold but also risky, not least because the shortfall on the public finances will be funded through borrowing at a time when costs of borrowing are rising.

A key potential downside is if markets become concerned about the sustainability of the UK public finances. Failure to convince could drive sterling lower, having already plunged to levels against the US dollar last seen in 1985.

Another risk is that a major fiscal boost to the economy may lengthen the Bank of England’s battle to tame inflation. With the Bank of England raising rates again this week and the markets expecting a further rise in November, we have a situation where rate-setters are tapping on the brakes with increasing force while the UK Government is at the same time putting its foot hard on the accelerator. Higher interest rates will partially offset the Chancellor’s plans.

Notwithstanding these risks, alongside measures to limit energy price rises on both households and businesses, there are clearly positive investment effects too. The scrapping of corporation tax rises and impact of reversing National Insurance increases will be particularly welcome news to hard-pressed businesses focused on the domestic market.

When it comes to listed companies, domestically-focused stocks are more prevalent among the mid-cap and smaller company parts of the UK stock market. This year has shaped up to be a particularly torrid one for mid and smaller caps as the outlook has worsened. While the FTSE 100 Index of large companies has declined by about 5% since the start of the year, medium-sized and smaller company shares have shed almost a quarter of their value.

With so much negativity priced into domestically-focused companies, contrarians may now be tempted to invest in them given the more helpful news on tax and energy costs. However, I would urge a little caution.

The prospect of a very deep recession has faded a little due to recent measures, but the UK economy is still facing a challenging period. Real household incomes are being squeezed, hurting consumption, and major increases in borrowing costs are going be extremely painful for those re-mortgaging.

As the Bank of England admitted this week, the UK is likely already in a recession. It may be shallower than it would otherwise have been, but this is not yet reason for excessive bullishness towards domestically-focused stocks.

When it comes to large UK companies, these have relatively low exposure to the domestic economy and high weighting to sectors that have historically proven resilient in times like these.

In aggregate, about three-quarters of revenues of FTSE 100 firms are made outside the UK, much of which is in dollars. In the near term, the strength of the US dollar should help flatter profits and dividends for the companies when converted into sterling.

The large end of the market also has an abundance of exposure to energy, healthcare, and consumer staples. These have historically held up well in periods of high inflation and struggling growth. Consumer staples companies produce the day-to-day “must have” stuff people will buy whatever the state of the economy, and healthcare companies are also less sensitive to the economic cycle. Together with energy companies, these three sectors represent almost half of the largest UK listed companies by size.

The good news is valuations of large UK equities look attractive overall, both compared to other developed markets and their own long-term trend. They also provide a relatively attractive dividend yield of approximately 4%, which is more than double the dividend yield of global equities.

Many private investors have shunned UK large caps for several years as the market has lacked the excitement of a meaningful tech sector while at the same time under the long shadow of the drawn-out Brexit process. Yet we are in different times now.

The days of ultra-low borrowing costs and vast money printing by central banks have been eclipsed high inflation and rising borrowing costs and the markets and types of companies that are better adapted to this won’t be the ones that were the winners of past years. It would be wise to take a fresh look.

Jason Hollands is managing director at wealth management firm Evelyn Partners.