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Steve Davis, Jupiter Unit Trust Managers

Politics and portfolio positioning, or why “an ounce of prevention is worth a pound of cure”

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The UK economic recovery remains strong and we can now see wage growth coming through to drive the next phase of growth. However, uncertainty over the outcome of next year’s general election calls for rigorous stress testing of our portfolio and forward planning that should stand us in good stead whatever the political hue of the country’s next government, says Steve Davies, co-manager of the Jupiter UK Growth Fund…

The 2015 General Election will be, in our view, the most binary for markets since 1992; if the Conservatives emerge as the largest party, either independently or in coalition, the UK stock market and the pound are likely to rally; a Labour win, on the other hand, could see a fall in the stock market and the currency on concerns that the party may be anti-business and unable to exert sufficient fiscal discipline to bring the deficit down.
 
At this stage, the polls make it too close to call who will win and there is an ever-increasing prospect of no overall majority, leading us into the complex world of potential coalition deals or the possibility of the largest party choosing to operate as a minority government. In a world of fixed term parliaments, the latter may not prove as unstable as normally feared, but the market is still likely to shoot first and ask questions later.
 
Either way, the situation will evolve as we get closer to the election. If employment continues to grow and wage growth accelerates from here, we would expect this to improve the Conservatives’ chances of victory. It is noteworthy that the gap between Conservative and Labour in the polls has narrowed from around 6 points at the start of 2014 to virtually zero now as the UK economy has continued to improve.
 
We continue to run our funds with the primary focus on the medium and long-term but the binary nature of this election means that we will need to be tactically nimble as the polls evolve and Election Day approaches.

So how we should position ourselves as polling day in the UK approaches? If the outcome remains unclear or Labour looks likely to win, we would expect to raise cash levels in advance of the vote (we are currently at 5% in cash), potentially holding the cash in dollars rather than sterling (as we did in the run-up to the Scottish referendum). We could strip back our allocation to domestic companies such as retailers and house builders, as well as the big banks. We would likely also take the opportunity to add to existing positions which should benefit from a stronger dollar (such as Compass or Experian) and we have a reserve list of other dollar earners that we may choose to add to the fund. We currently have 8% of the fund in overseas stocks, notably Apple and BMW, and these should provide a hedge against a post-election sell-off in sterling.

Uncertainty often creates opportunity for the long-term investor and a healthy cash buffers should enable us to take advantage of any post-election turmoil. We will keep a particular eye on sectors like utilities and bookmakers (where we currently have no exposure) where the market might over-react to fears of a more interventionist approach from a Labour government.

Recent data suggests the UK economic recovery remains on track despite the headwind of continuing weakness in the Eurozone. We have seen a continued increase in private sector jobs and we expect that growth to continue. We have thought for a while that official statistics were underestimating the rate of growth in wages. Talking to a selection of the companies we are invested in, the vast majority have awarded pay increases of 2-3% in 2014 and the latest official data gives additional support to this view, with private sector wage growth rising to 2.4% on an annualised basis in the 3 months to August3. This may well improve in the New Year (when many annual pay settlements are agreed) if labour market conditions continue to tighten.

On the other side of the equation, living costs have not risen as fast. Price wars between supermarkets and weaker fuel prices are likely to be positive for the amount of disposable income each consumer has. The Asda Income Tracker chart below shows how disposable incomes have risen in recent months and we would expect this to pick up further from here.

If this trend continues, then strength in the domestic economy could boost companies – we have holdings in Dixons Carphone, ITV and Howden – that make most of their money in the UK.  The picture is less rosy for many of the big global multi-nationals, which we believe could see seeing earnings overseas fall, with results further hampered by the relative strength of the pound against the euro and other emerging market currencies.  As China’s and Europe’s economies continue to slow, some second half budgets could start to look over-ambitious and we could see further profit warnings between now and the end of the year.

So, while we wait for the politics to unfold, the current bias of the fund is still tilted towards domestic UK operators that are delivering strong profit growth (including the UK banks) and we remain zero-weighted in both oil and mining as commodity prices continue to tumble.

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