With elections behind us, who holds the power?

Who holds the power: the government or the market? In this episode, Simon Gergel discusses the aftermath of the recent UK election, marked by a significant Labour victory. He explores the market response and highlights where opportunities are being found today. Listen in now to find out more about the impact of a new government and what it means for investors.

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JC: Hello and welcome to A Value View from the Merchants Trust. In each podcast, Simon Gergel, Fund Manager at the Merchants Trust, offers his thoughts on developments affecting the UK market and what it means for investors. Simon, it's good to be with you again.

SG: Good to see you, Jon.

JC: Well, we're going to talk politics, for this episode. We're not a politics show but for the last 30 episodes, we've quite rightly focused on our markets, on UK businesses and the trends driving the fortunes of those two. But this year, the political environment has been hot, particularly with respect to a number of big elections that have taken place and arguably an even bigger one yet to come. The UK, France and earlier this year India have all balloted their subjects and citizens. In November, it'll be the turn of the United States. So, Simon, I'd like you briefly to don your political hat and untangle what all of this has meant and might mean for markets and in particular for the Merchants Trust. So, let's start with the UK, Simon. As expected, a big victory for the Labour Party under Keir Starmer, Sir Keir Starmer, no great surprises other than perhaps the scale of the conservative’s defeat. But what was the market response? What does it mean?

SG: Well, overall, the market response has been almost nothing. You would hardly notice it. I think there was a slight dip when the election was announced, simply because there was a bit more uncertainty for 5 or 6 weeks, but there's been virtually no movement in the market that's discernible to do with the actual election campaign or the result, because, as you say, it was quite well telegraphed. Perhaps within the market, there's been a little bit of a move towards some of the housebuilding areas. We might cover that in a minute, but the overall market response has been pretty neutral, pretty modest, and in a way that's quite good, because what it means is that there wasn't a big surprise for investors that the, investors and commentators have got used to the idea of a Labour government coming in and replacing the Conservative government, and the investors seemed pretty relaxed about that, which is clearly a good thing.

JC: So, it’s sort of priced in, I guess they were so certain of the likelihood of a change of administration that that not only was it not a surprise, but it didn't move markets.

SG: It hasn't moved markets at all, really. And if anything, the scale of the majority means that you've got a government that now can do things if they want to. They have the ability. Whereas the previous Conservative government, although they had a quite large majority, they were quite split and divided on the contentious issues.

JC: So, markets not surprised. What then might the Labour government do that could shift sentiment. A new administration, one that's going to plot a different course to the Conservatives, a new chancellor who has her own vision for the future of the UK. Are we likely to see changes there that could have an impact on markets, on the businesses that you invest in?

SG: Well, it's a great question. I think the irony is, although Labour have talked a lot about change as their big idea and that big word, when you look at what they're planning to do, it's actually not that different to what the conservatives are doing. And they're making a point about no big changes in income tax and the other big taxes. And one thing we did learn from when Liz Truss was prime minister, the one thing we can be grateful to her for is that markets will actually limit what politicians can do in terms of unfunded spending, or you know, taxation policies that don't that don't balance the budget. So, I think there's limited room for manoeuvre and Labour are being extremely careful to try to work within a prudent financial framework. So, I think in terms of big ideas, big spending plans, we're not going to see a major change. In terms of the detail, we will see some changes, clearly. One big area that we may see changes is the planning reform. And planning has been difficult under the Conservatives. They haven't built anywhere near enough homes, and perhaps other infrastructure that we've needed as an economy. And hopefully we'll see an easing in that area. So, one reaction we've seen in the stock market is companies involved in the housing process, not so much the house builders, but the manufacturers of materials, distributors of building materials. Those types of companies have generally performed quite well in the last few weeks. On the hopes that activity would pick up in due course.

JC: And, of course, the King's speech, the recent King's speech, the first of this administration made a point of highlighting that, didn't it? They want to turbocharge building in the UK, unleash that part of the economy as well. So, for businesses, for builders and the Merchants Trust obviously hold some of those, that offers potential, doesn't it?

SG: Yes, we think so. And we've felt for a while that the housing market and construction generally needed to increase in terms of activity levels. And that's one of the reasons why we've got quite decent positions in that area. On top of that, the valuations of many of these companies are quite depressed because they've been through a difficult time. So, it will take time because planning reform doesn't happen overnight. Even if you get a new building site today, it's going to take you a year or two before you can start building houses there. But in due course, you should see a pick-up in activity.
And there's also a massive need for repair and maintenance and infrastructure spending in lots of areas where spending hasn't been as high as it should have been. So that's an area that we remain quite optimistic on in the medium term.

JC: And critics of the new Labour administration, those that were warning against it, of course, opponents of, the Labour Party would have said that their record with the economy, has been patchy, if not poor, to say the least. Is there do you think any kind of fear or concern among those that you speak to investors and otherwise, that the future Labour government might, you know, might cause problems in that respect? Or have they fully fallen for this notion that Labour will continue with the same policies, economic policies in many respects as the previous administration?

SG: It's hard to know what everyone is thinking, but so far, the general view seems to be that at least in the first term, that they're going to be pretty prudent or pretty sensible, and that they will be relatively constrained by the level of debt and the deficit that we've got at the moment. So, there's not that much more they can do. In due course over two terms, if they get re-elected, who knows what might happen further down the road. Don't forget, the end of the last Labour government coincided with the global financial crisis. So, you know, some people, some supporters of Labour might say that wasn't their fault and others might say it was. And, you know, we can get into lengthy discussions on that. But I think as we sit here today, we don't see a major change in the financial situation for the UK.

JC: And of course, we're not a political podcast, so we wouldn't get into much detail there as well.

SG: And just to add to that, sorry, if you look at where inflation is today at 2% is bang in line with the Bank of England's targets, economic growth in the UK is in line with, if not better than, many of the other countries in the G7, the largest seven economies in the world. So, we're in an okay position actually in terms of the UK.

JC: So, we're sort of reassuringly, perhaps even boringly predictable something that a lot of people would’ve been looking for us to be for quite some time.

SG: Yes. We've been saying for a while that borings good, particularly in the area of politics and one of the problems in the UK for many investors for the last really 7 or 8 years since the Brexit referendum on 23rd of June 2016, which we all remember very well, is that the UK has been seen as difficult to invest in politically because politics was so uncertain with Brexit, with Jeremy Corbyn, with a number of other things going on, Liz Truss. And now actually politics in the UK looks less exciting, perhaps more boring than in many other countries, whether that's across Europe or even across the Atlantic.

JC: Let's look at one of those countries, because in France, politics certainly isn't boring. Another poll there, parliamentary elections and there’s been a great deal more uncertainty as a result of the outcome there, which was a vote for the hard left, not for the hard right, but still a vote for a quite extreme version of the way that our politics might go in that country. Now, I know that you’re not focused purely on French markets and French politics. But of course, it did have, an impact on French markets and that negative impact can spread. So, what's your take on that?

SG: Well, I think over and above what the actual result was, what you're seeing in France, as you're seeing in many countries, is a polarised electorate and a population with some very, divergent views on the right and the left. And that is not going to go away quickly. Even the UK, to be honest, we've had, you know, with a reformed policy party, we've had movements to the more extreme fringes of politics, although Labour has united everyone really, in terms of an anti-Conservative vote, which is what really the election was about. But I think in France you're seeing a polarised electorate, and the middle ground has been chosen middle to left. With a sort of alliance in order to stop the far right, I think. But I'm not sure that there's a great mandate for left wing policies, particularly either. So, I think that uncertainty will remain under the surface for quite some time.

JC: But the markets, the French markets were hammered, weren't they? That hit the number of businesses obviously in the index. Are you through the you know, the businesses that you are invested in, very internationally focused businesses. Are you in any way impacted by this?

SG: Well, we have one company that is listed in France which has a small impact, but in terms of the underlying exposure of the companies, including that one actually is very modest exposure directly to France in the portfolio. So, it's not a big impact in terms of the underlying economics of the businesses we're invested in. But I think it is a sign that uncertainty, political uncertainty will remain, certainly outside the UK for a while.

JC: Yes, exactly. In Europe and elsewhere as well. Looking ahead, the world will be waiting with bated breath on the outcome of November's US presidential election.
That's the big one, I guess, for this year. The recent assassination attempt on Donald Trump has only added more heat to a political temperature that's already looking like it's boiling over. Again, what, if anything, are investors to make of this? Because America, wherever you are, Simon, America matters, doesn't it?

SG: America absolutely matters to investors and our stock markets follow the American stock markets with, you know, very closely the trends you see are very similar, except the big difference is we don't have a massive technology sector in the UK. So, the boom you've seen in US technology shares affects the UK in a slightly different way. So yeah absolutely, what happens in the US elections this year will really matter for foreign policy, but also for economic policy and for the market sentiment, yeah.

JC: Is there anything you can do to position the trust to adapt or cope with the uncertainty that may come from, say for instance, a Trump victory, a more isolationist, America. All of these are hypothetical situations. But do you think about that? Is that something you have to consider when it comes to the construct and shape of the portfolio?

SG: We try to think a little bit about these types of risks, but they are very difficult to think about. And we find we're better off spending most of our time actually looking at individual companies and trying to work out the prospects for their business, because generally they're not that dependent on geopolitical events. I mean, if you're investing a defence company, for example, obviously you are affected by those types of policies. But if you're investing in a company that might have a lot of exposure to the construction industry in America, and we’ve got some of those. Yes, there'll be some impact on who's in the White House, but it's probably not going to make that much difference to the direction of travel for the US economy. And similarly, a global pharmaceutical company or a global energy business, they're not really going to be too affected, probably by which colour the white House is, you know, leaders.

JC: Okay. Now enough politics. Let's talk on, a few other aspects of what you're thinking about in terms of the trust. What have you been focusing on for the trust over the past few months? Where are you seeing opportunity at the moment?

SG: Yeah, well, it's very much back at the individual company level. The UK stock market remains, as we've discussed many times before, very lowly priced and within that there's a huge dispersion of valuations. So, there are many, many companies trading on really attractive low valuations compared to the history. So, we've been looking through those sectors to try and find interesting opportunities. We've added two companies in the last six months in the real estate sector, one that owns GP surgeries and one that owns student accommodation. Those are both interesting situations where you've got very strong tenant profiles, very strong underlying demand for that accommodation. and that and those and those, surgeries, those offices, and limited supply. And that should be supportive. Plus, you've got businesses where the valuations have come down because interest rates have gone up. And we see potential there for a rerating and for decent growth. We've also bought a company that makes components for the automotive industry, a global business world leader in what it does. Very lowly rated for some technical reasons. So, we are continuing to find opportunities in, particularly the medium sized company area, I would say. I'll say the large companies tend to be more, more closely followed by global investors and less out of line. But the medium sized companies are often where the bargains are, particularly if you see an outflow from many UK fund managers who had to sell these things.

JC: And finally, Simon, we're seeing what seems like, a resurgence of mergers and acquisition activity, M&A activity, talk us through that because it's been quiet on that front. But maybe signs that things are changing.

SG: Yes, I think a lot of things have come together this year. So, we've had low valuations for a while, but we have had political uncertainty, I think that's now easing. We had very volatile interest rates and rising interest rates last year. This year they've stabilized and if anything, expectations are coming down, which means it's easier to finance deals. And on top of that, as you say, companies are in generally pretty good shape and the economies are resilient. So, you're seeing a resurgence in corporate takeovers and to some extent, private equity coming back in. In the first half of this year, we’ve seen 17 approaches for companies in the Footsie 350 index that’s of the 350 largest companies in the UK, 17 of them have been bid for, so almost 5%, which is extraordinary. That's in six months.

JC: Is that because basically, there cheap, perhaps undervalued, this is the perfect time to invest?

SG: I think that's what's happening. If you look and compare that to last year in the whole of last year, there were two bids for Footsie 350 companies. So, the rate has stepped up dramatically. And I think it's to do with valuation it’s to do with confidence of the companies buying them. And perhaps a realisation this might be the last chance because if the stock market does start to move, the valuations could go up a lot and they're starting to go up. So, I think companies are saying now's our chance. If we want to buy this Great British business there’s trading on a massive discount to where it should be, now's the time to act.

JC: Okay. Well, Simon, unfortunately we're out of time. But thank you very much indeed for your thoughts.

SG: Thank you, Jon, good to see you again.

JC: Good to see you. And thank you for listening to A Value View from the Merchants Trust. You can find out more about the Merchants Trust and read and watch Simon's latest investor notes by going to MerchantsTrust.co.uk. Thanks again for listening. And until next time, from all of us here at the Merchants Trust. It's goodbye.