Dear all,
This note covers our thoughts on Friday’s announcements by Kwasi Kwarteng and the Satis view on, and reaction to, the ‘fiscal event’ and how it may affect you.
Wow- That was some mini-budget!
Kwasi Kwarteng has announced the most radical set of tax cuts in a generation. While several of the measures were well trailed, most commentators were surprised at the scale of what had been announced. The Budget (this is how I will refer to it from now on) consisted essentially of a series of tax cuts with little detail on how these cuts are to be funded. These tax cuts will have the largest and immediate effect on the better off, our clients and me. However, the impact on our investment portfolios has been fast and sharply negative, and I am concerned about the impact on our children.
Intuition is dangerous. Most readers of this note know of our belief in markets. (Not that the markets get everything right – but they are predominantly efficient when it comes to pricing assets.) The markets’ verdict has been resoundingly negative. Specifically, our exposure to sterling fixed interest – whether through corporate bonds or gilts – has dropped in value sharply. And this is a substantial continuation this year thanks to previous changes in interest rate and inflation rate expectations. Bond markets price assets according to future cashflows. The market believes that interest rates are now likely to move higher than expected. Interest rates rise because those seeking to borrow have to offer higher rates to get those with capital to lend them money. The rates rise because a) lenders think interest rates are going to rise generally and they want a rate that is attractive, and/ or b) lenders are nervous about the creditworthiness of the borrower. So, the initial reactions of the markets are that the government will have to pay more to borrow money – this is because of the scale of the borrowing implied by the Budget announcements. There was, of course, no Office for Budgetary Responsibility report, so we do not yet know their analysis. Currency markets reacted quickly, pushing sterling to its lowest level against the dollar for over 35 years. The UK stock market also fell sharply (the FTSE 100 was down 1.97%).
The market is effectively offering a negative verdict on the Budget, suggesting that interest rates are going to be higher than expected and the inflation rate will rise higher than originally predicted. The Chancellor is expecting that growth in GDP will pull the UK through the recession quickly. There will be increased tensions between the government and the Bank of England. The government will want to see growth encouraged – which means low interest rates – and the Bank of England will want to quickly bring inflation under control, which generally means high interest rates.
I realise that I have said little positive about the Budget. Is there anything positive in the Budget? There are a few points. The most obvious one is that Kwasi Kwarteng at least has the courage of his convictions, which I admire. To announce all this just three weeks into the job takes real…guts. The scrapping of the proposed increases to Corporation Tax means, other things being equal i.e., less Corporation Tax, so more distributable profits, so higher dividends. That is good. I welcome turning the clock back on IR35. This will mean a reduction in net tax (in practice if not in principle) as nervous companies place the burden of deciding an individual’s status back, to some extent, on the individual. While the National Insurance rise was cancelled, the NHS funding (as I understand it) was not cut. The falling exchange rate helps exporters (and makes imports more expensive, which fuels inflation) and helps the sterling performance of our equity exposure. Our (your) exposure to UK listed companies is modest (typically 4% – 5% of equity exposure), and a declining sterling rate helps when so many assets are priced in dollars. Sadly, the US market has also been falling this year, but if you are a sterling investor then the exchange rate helps to mitigate this decline. Tweaks to the Enterprise Investment Scheme, the Seed Enterprise Investment Scheme and pension charge legislation are very niche but welcome.
The message conveyed by the removal of the bonus cap on bankers’ remuneration is extraordinary, it will help very few people and will be particularly unpopular in Red Wall constituencies. It does at least demonstrate a desire to get rid of what some see as onerous EU legislation.
What to do?
In terms of investment portfolios, we will continue to rebalance, but we will not be offering a knee-jerk reaction to this Budget. Reacting to current news stories is immensely reassuring but generally impacts negatively on medium term returns. Our underweight position in growth stocks remains encouraging. Our lack of home (UK) bias remains a sound decision. Many clients have considerable exposure to fixed interest assets – bonds and gilts. There remain good reasons for holding these assets despite their falls in price, but if you would like to discuss these reasons do not hesitate to contact your adviser. It is a mathematical truism that since the price dropped, the expected returns have risen.
Continue to consider tax planning. While the Chancellor has today (Sunday) confirmed that he plans further tax cuts, his room for manoeuvre here is surely limited. If these tax cuts are not self-funding, then some combination of a) tax rises, b) inflation and c) cuts to public spending must result. Plan with these scenarios in mind.
There have been rumours of changes to the pensions lifetime allowance. They would be welcome.
Consider how to advise and assist the next generation. They have no real experience of rising interest rates. They will need guidance (and maybe money) sooner rather than later.
Finally.
Thank you for reading this far. While tax liabilities for many of our clients will be reduced, investment portfolios have dropped in value. Our faith in capitalism and in the next generation’s inventiveness is undented. While the UK is doubtless going to experience tough times, history suggests that these times will pass. Our thoughts continue to be with those suffering in Ukraine. More than ever, at times such as these we would like to hear from you. If there is any aspect of your finances and financial planning that you would like to discuss, do contact us.
Thanks,
Ben Sherwood