Fiscal spending is a hot topic in markets at the moment - both US candidates for the presidency are making their promises on fiscal spending, while Japan recently announced a postponement of the VAT hike and an extensive fiscal stimulus program. As we wrote about in a recent blog post, we think that in the UK the new Chancellor will deliver a fiscal boost in his Autumn Statement.
Quite a few readers have asked us how we adapt our portfolios in anticipation this view? We believe the clearest implication of increased government spending (or tax cuts) for markets could be for mid-cap UK equities, especially stocks that benefit from infrastructure spending like contractors and homebuilders.
As highlighted in Lars' post, the mid-cap FTSE 250 equity index sharply underperformed the large-cap FTSE 100 following Brexit, and has only partially recovered this relative underperformance. An important part of this underperformance can be attributed to the weakening of the pound versus other currencies, as the larger companies in the FTSE 100 benefit more from currency weakness. Furthermore, the FTSE 250 index is more exposed to what goes on at the grass roots of the UK economy than the FTSE 100. With this in mind, we have recently increased our exposure in portfolios both to the FTSE 250 and to a basket of equities that may benefit from increased infrastructure spending.
Elsewhere in portfolios, we have been short the pound since the night of the referendum, as Willem wrote about at the time. Since then, the pound has weakened considerably. The pound has moved much closer to our post-Brexit “fair value" of 1.28 for GBP/USD. In light of this we have reduced this short position considerably of late as we believe that some of the downside risk scenarios for sterling have been removed by recent positive UK economic data. We also believe that short pound has now become a crowded consensus position.
We don’t see the prospect for greater government spending as a factor that significantly changes the outlook for gilt yields or the pound. While 10-year gilt yields of around 0.7% are low, they do reflect a very low interest rate environment and it could be some time before the Bank of England presses the ‘hike’ button. The pound is typically more influenced by financial market factors such as interest rates and the Bank of England’s bond purchases than economic growth alone.
The window of opportunity for the government is autumn: we have the Conservative party conference in October and the Autumn Statement scheduled for 23 November. With this excitement on the horizon, it almost makes you glad summer is over.
Adapted from our original Macro Matters piece, Maybenomics - the Bank (of England) and budget boost.