Some experts are starting to see good reasons to be optimistic about the UK economy, particularly over the medium to long term, despite some short term uncertainties around Covid 19 and the effects of Brexit on supply chains. Investing in small and medium sized companies is one of the best ways of capitalising on potential opportunities in the domestic economy as these firms tend to operate mainly within the UK. These are the businesses which Mercantile Investment Trust focuses on.
The UK economy is recovering well from the pandemic recession. Between April and June this year GDP grew by 4.8%, according to official figures. That leaves output only 2.5% below the pre-pandemic high (having fallen by almost 25% at the nadir last April). Mercantile’s investment managers Guy Anderson and Anthony Lynch believe the outlook continues to be promising for investors.
Following on from ‘freedom day’ and the opening up of theatres, sporting events and other venues, a ‘return to the office’ is expected to have a significant impact. Even though many firms are likely to adopt a hybrid approach, combining office and home working, workers returning in larger numbers to town centres will provide a boost for many local businesses.
Concerns that the end of furlough would cause a sharp uptick in unemployment are receding as job vacancies have hit new highs 1. It is worth bearing in mind that while some companies had to shut up shop, many new businesses were created during the pandemic. Indeed, 2020 was a record year for new business set ups in the UK and the trend continued in 2021. Data from HMRC shows that in March 2021 more new businesses were created than in any other month since records began in 1989. There has been “a wave of entrepreneurialism” in the UK according to accountancy firm UHY 2.
Consumer confidence has also been returning. Indeed, according to PWC’s Consumer Sentiment Survey 3, consumer confidence is at its highest level since the regular survey started in 2008. Confidence levels were high across all age groups and all regions. This bodes well for consumer spending as there is still a considerable amount of pent-up demand from consumers who were unable to spend as much as normal during the pandemic and have accumulated larger than average savings pots.
The housing market is also holding up, despite fears of a slump after the ending of the stamp duty holiday. The average house price rose by 1.2% in the three months to the end of August, taking the annual rate of price growth to 6.1%, up from 2.8% in August 2020 4. Continuing buyer demand coupled with fewer properties on sale means that while growth is slowing down, house prices are still rising.
This is all good news for companies. This year’s recovery has already boosted companies’ earnings growth and dividend payments have rebounded among UK companies of all sizes. Earnings growth is expected to be strong overall this year even though businesses will start to face headwinds in the form of rising cost pressures such as higher wages, rising commodity prices and increasing corporate taxes in the months to come.
The improving health of the UK economy and UK companies is good news for investors. Not only is there the prospect of growing profits, as companies benefit from the bounce back in the domestic and global economies, but UK equities are still on relatively attractive valuations compared to other global equity markets. This is partly a result of investors steering clear of the UK market in recent years due to concerns about the lack of a Brexit deal.
Now the UK’s exit from the EU has happened, investor sentiment is changing, helped by the UK’s successful vaccine rollout and a friendly business climate. The future is looking brighter again, and investors at home and abroad are being attracted back to UK stocks. By investing in Mercantile, investors can seek to take full advantage of this trend, thanks to its diversified portfolio of UK medium and smaller companies.
Medium and smaller companies tend to be more focused on the domestic market than larger companies and gain most of their revenues from it. They span a wide variety of industries, tend to serve niche markets and have more scope for growth. Historically, shares in these companies have significantly outperformed those of larger UK companies. Although past returns are not a reliable indicator of future returns , over the past 25 years, the FTSE 250 (excluding investment trusts), which tracks the returns from medium sized UK companies, has delivered over 10% annualised total return, versus the FTSE 100, tracking larger companies, which has returned 6%.
Another factor in favour of investing in medium and smaller companies is their attraction to investors looking to make acquisitions. Private equity firms have been particularly active in making acquisitions in the UK this year, perhaps a reflection of the UK market’s relatively attractive valuations of specific companies.
Stock selection is always key of course and Mercantile’s managers, Guy Anderson, Anthony Lynch, and the wider team undertake over 350 meetings a year looking for companies that meet their criteria. This thorough and disciplined approach enables the managers to select businesses that have the potential to grow into tomorrow’s market leaders.