Russell Silberston reviews the UK budget announcement, delivered by Chancellor Philip Hammond on the 29th of October 2018.
Lindsay Williams: The UK’s budget was unveiled by Philip Hammond, the UK’s Chancellor of the Exchequer yesterday. Did it signal the end of austerity? On the telephone now is Russell Silberston, Head of Multi-Asset Absolute Return at Investec Asset Management in London. Russell, it is being hailed as the end of the austerity but it also seems to me that it is a little bit cheeky in that it probably has a political motive, even more than previous years.
Russell Silberston: Hello there, Lindsay. Without a doubt, I think all budgets tend to be quite political and the political angle of this was foretold at the Conservative Party conference last month when Theresa May, the PM, basically said we are coming to the end of austerity. The term itself is one of those very emotional words, meaning different things to different people, and there is no doubt that, somewhat fortuitously, the Chancellor has increased spending but he has been – I say “fortuitously” because he has been quite lucky because what has actually happened is, despite pretty low economic growth forecasts and obviously the cloud of a possible hard Brexit on the horizon, the fiscal watchdog in the UK, which is called the Office for Budget Responsibility, has, somewhat luckily, found an extra £13 billion pounds and has changed some of his assumptions and that has really enabled him to increase spending, particularly on the National Health Service, which clearly in the UK is one of the closest things to a religion we have.
Lindsay Williams: Yes, indeed. When it comes to the fiscus, the fiscal environment giveth, Mr Hammond has given away or Chancellor Hammond has given away. It is, in many people’s minds, a good budget because the first thing that the man and woman in the street normally looks at is what he has done or she has done in the past to income tax cuts and they have been brought forward apparently to 2019, again politically charged.
Russell Silberston: Yeah, absolutely, without a doubt, yes. So the amount you can earn tax-free has been risen and also the threshold for the higher rate of tax has also been increased. So, actually, literally across the spectrum people are modestly better off. So, yeah, it is undoubtedly a political budget but the first thing I always look at in any budget anywhere in the world, in fact, is what are the underlying assumptions behind this because, obviously, if those underlying growth assumptions are wrong, you know receipts turn out to be wrong, if expenditure turns out to be higher than accepted, then the whole thing falls apart.
So, you know, if you actually looked in those term, the forecasts are actually pretty modest actually, not looking for particularly sort of high growth going forward, somewhere in the region of sort of 1.5% or so but what has actually happened is that the fiscal watchdog has said that the sustainable rate of employment and therefore unemployment in the UK is much lower than they expected and therefore their expected receipts from taxation are therefore higher. So, yes, we can spend a little bit more but he has also held out the promise of sort of a Brexit dividend if we actually manage to get a decent withdrawal deal and a future trading arrangement through the fiscal process.
Lindsay Williams: So a Brexit dividend rather than a Brexit slush fund in case the costs of doing business in the United Kingdom, whether it be because of the queues at the ports or whatever, there is no sort of emergency fund to cushion the blow as the transition takes place.
Russell Silberston: Oh, there is, there is. It is around just over £4 billion. We sort of band these numbers around but, yeah, £4 billion I think is a drop in the ocean, unfortunately. You know public sector spending is in the region of 280 billion, so it is not a massive amount of money but, yes, he does have some but it was very political.
It’s jam tomorrow and part of the political package I think, even talking to his own MPs in his own party, saying we cannot afford to sort of crash out of the EU with no deal because the sort of promised extra funding, because this is largely back-loaded by the way, is just not going to come through. So there was a strong political message there as well. You know, let’s get a decent Brexit deal and, actually, things might look even better. As we expect, actually, we should see growth pick up if we are get a decent deal.
Lindsay Williams: Before we have a look at the markets and what it might mean for investments in the future, let’s have a look at the NHS. I think the figure that I saw was £20.5 billion in real term increases in funding to what you called a religion and, of course, incredibly, incredibly important and a very emotive subject whenever NHS comes up. It seems like he has bowed to years and years of criticism of the Tory Party and its attitude towards the NHS.
Russell Silberston: I personally think that is slightly unfair because NHS spending has been protected in real terms but what has really happened in the UK over recent years, of course, is the population has grown. So in 2007/08, the population was 61.5 million. By fiscal ‘18/19 it was 66 million so that is another 5 million people. Of course, the spending per capita has gone down and, of course, that is what people experience. So it is understandable why people can see that and, of course, the population is getting older and it is older people that really experience it at the frontline.
So, yeah, it is one of the largest public spending items we have and he has really increased it quite substantially. 80% of the funding – 80% of the extra money has gone towards the NHS. So it is very political in that respect but I don’t think anyone is either surprised or begrudges that, I mean 3.4% increase, which is clearly reasonable.
Lindsay Williams: What did you and your team at Investec Asset Management in London think of it when it started to unfold? Did you immediately start licking your lips, rubbing your hands together and say well, actually, we have got to tweak our portfolios a little bit or was it steady as she goes?
Russell Silberston: I think I would separate the sort of macro-economic and market impacts versus the sort of political impacts. The latter, this was all about the latter. It was purely political. From a macro-economic forecast perspective, it changes very little because most of the spending is back-loaded and, because of that, the uncertainty over sort of 3 or 4 years is massive.
Where you might see a specific market interaction is very much at the micro level, so things like house-builders on a sort of government scheme called “Help to Buy” but, actually, sterling and the government bond market, the yield market, were largely unchanged because, looking forward, this is all going to fall apart if we don’t get a deal literally in the next couple of months.
So the market, I would say, was sort of reserving judgment on this. It all looks fine and dandy but let’s see what happens on Brexit and that is really what we are focussing on. It is great that we have revised away some of the problems we have had and, actually, we see it look better and people are going to be marginally better off but ultimately there is a very dark cloud on the horizon that needs to pass I think before people will perhaps become a little bit more confident.
Lindsay Williams: Yes. Given what you have just said about waiting and seeing what happens with Brexit, probably my next question, my final question, is a little bit puerile but what are you doing at the moment? I mean how are you extracting wealth from the UK market? Will it be gilts or will it be the sterling or the equity market? What is your attitude?
Russell Silberston: Our view is that there is a pretty big risk premium priced into the market for Brexit, a hard Brexit that is, and we think that is probably overdone. So, in reality, we think there is probably a 10% probability of the UK crashing out of the EU without a deal. The sort of bet in mark-to-market expectations are more bearish than that.
So the way we plan it is, actually, looking to sell gilts and we are looking for yield to rise, explode when something else is going on globally as central banks are looking to slowly but surely escape ultra-easing monetary policy and, of course, we can see the ramifications of that in global markets. If we look at equities over the last month or so, people have been realising that the prop that markets have had over the last few years are beginning to be taken away and the Bank of England are in exactly the same camp. They are looking to raise rates and, therefore, our bias is to be shorter gilts, underweight gilts, looking for the yield to rise because we think: (1) that is the sort of path of least resistance from central banks; (2) the market is underestimating the chance that we actually reach a deal and exactly the same in sterling as well. So we are dip buyers in sterling and would also be favourably looking for opportunities in the equity market as well. So, you know, actually, uncharacteristically positive for me but there are a lot of uncertainties but we think those sorts of uncertainties are probably mispriced at the moment.
Lindsay Williams: Good. Russell, thank you very much for your analysis. That was Russell Silberston, Head of Multi-Asset Absolute Return at Investec Asset Management in London.
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