WeeklyWatch – UK reacts to a new Budget while the US faces a split Congress

22 November 2022

Stock Take

Takeaways from Hunt’s Autumn Statement

UK Chancellor Jeremy Hunt’s inaugural Autumn Statement was released last week, and received a very different public reaction compared to his predecessor’s ‘mini-budget’.

Hunt provided a sobering medium-term outlook, with a greater tax burden for the population, coupled with tightened spending – in contrast to Kwarteng’s September Budget, which offered tax cuts paid for by borrowing. It’s important to note that a lot of the tax increases are scheduled to take effect in the coming years, when it’s believed that the UK economy and consumers would be better equipped to handle them.

There are a few particular things to keep in mind when looking at it from an investor’s perspective, including the Capital Gains Tax allowance being reduced from £12,300 to £6,000 in April 2023, and then to £3,000 in April 2024. The tax-free dividend allowance is also set to be reduced over the same time period (from £2,000 now to £1,000 in 2023, and then £500 in April 2024).

Keeping an eye on the UK’s fiscal reputation

Hunt undoubtedly planned the Budget with the UK’s fiscal reputation in mind, hoping to convince financial markets that he and Prime Minister Rishi Sunak are serious about fiscal discipline.

At the same time, he had to strike a compromise between the need to replenish Government coffers and prevent the UK from entering a deeper recession (or at least reduce the deficit).

But the Bank of England may have some breathing room around interest rates after the Budget, notes Ben Lambert, Portfolio Manager at Ninety One. Ben says:

“While the [Budget] statement wasn’t necessarily headline grabbing, the objective was clearly to balance the roles of fiscal and monetary policy in reducing inflation, and we believe could be a precursor to a more cautious interest rate hiking cycle by the Bank of England.

“Market expectations for the peak UK base interest rate had soared to over 6% post the ‘mini-budget’ but has subsequently fallen to around 4.5% today. Initial commentary post the statement suggests the market may begin to factor in an even lower peak, which would imply we’re nearing the end of the rate hiking cycle.”

Since much of the Budget’s content was already known before its release, markets seem to have reacted relatively calmly. And, after all was said and done, the FTSE 100 actually ended the week marginally higher, despite the Office for National Statistics’ report that inflation reached 11.1% in October.

US midterm election results

The results of the US midterm elections were also more or less finalised this week. Although it was already confirmed that the Democrats would maintain their slim lead in the Senate, it’s now known that the Republicans have taken control of the House of Representatives.

US equities may be at more risk if the house is divided. One risk, noted by George Brown, Economist at Schroders, is a debt ceiling stand-off next year; 2011 saw a similar showdown that caused the S&P 500 to drop by nearly 20%.

But the result should be seen overall as a positive for the market. Brown comments:

“Our previous analysis shows this outcome ought to be supportive of risk assets. US equities have averaged annual gains of 12.9% when Congress has been split, compared to a more modest increase of 6.7% when a Democratic president has controlled both chambers.”

Split houses may benefit markets in part because they compel both parties to compromise, but also because it will temper some of their more extreme tendencies.

Reminders of the fragile global economic state

The S&P 500 and the tech-heavy NASDAQ Composite both declined last week, by 0.7% and 1.6% respectively, with growth stocks trailing their value-oriented counterparts.

The lower-than-expected US CPI inflation from the previous week played a significant role in this, causing the equity markets to soar on greater hope that the Federal Reserve would slow the pace of future interest rate hikes.

However, markets were unable to capitalise on this since statistics showing a decline in US industrial production and a sharp increase in UK inflation reminded investors of the precarious status of the global economy – serving as a prompt reminder that it’s about ‘time in the market, not timing the market’.

Wealth Check

The COP27 conference in Egypt, where world leaders and heads of state had come to discuss combating climate change against an increasingly challenging economic backdrop, came to a close last week.

One aspect of their problem was the energy ‘trilemma’. Three powerful forces are colliding on the world’s power markets at the same time, causing crises in energy prices, security and environmental impact.

What is the energy trilemma?

Put simply, this trilemma will force a return to carbon-based fuels, like coal and gas, in the near future. But on the other hand, it will quicken the transition to renewable energy in the long run. This is due to the need for Western nations to find climate-neutral ways to lessen their reliance on Russian fossil resources, which have become increasingly unstable since the start of the Ukraine war.

What are the negative effects?

The energy system is driven by a fluctuating balance between three pillars: supply security; affordability, which is determined by demand and supply; and the shift towards clean energy to lessen the impact of harmful emissions on the environment.

The first two pillars have been significantly impacted by Russia’s invasion of Ukraine, making the main natural gas supply into Europe less secure and fossil fuels significantly more expensive. This will have a short-term negative impact on emissions targets as more CO₂-producing fuel usage comes back online, with an increase in demand for coal and gas production outside of Russia.

What are the positive effects?

These pressures should compel global policymakers to speed up the switch to green energy. Thanks to this, they’ll be able to improve energy security while staying on track with their emissions goals. This will also encourage technology providers and other business in the sector to step up their efforts to accelerate the transition to sustainable energy.

Countries might also consider expanding their nuclear-power supply, though this is unlikely to offer much relief in the near future. Reducing dependency on fossil fuels and boosting energy security still require solutions that generate clean energy and improve efficiency.

What are the long-term effects?

Looking to the longer-term future, the events in Ukraine should speed up the shift to renewable energy, offering investors more opportunities to use their money as a force for good.

The Last Word

“Fighting climate change is not just a moral good – it is fundamental to our future prosperity and security. Russia’s invasion of Ukraine and contemptible manipulation of energy prices has only reinforced the importance of ending our dependence on fossil fuels.”

– UK Prime Minister Rishi Sunak discussing the need to fight climate change, speaking before his departure from COP27.

Ninety One and Schroders are fund managers for St. James’s Place.

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SJP Approved 22/11/2022