Take advantage of volatility in UK small caps
This article first appeared in the October edition of Professional Paraplanner magazine It’s been a...
Will there be a recession in the UK? This is the question on everyone’s lips as the cost of living continues to soar and consumer confidence tumbles.
More than 90% of people are now paying more for food, energy bills, and fuel, according to figures published by the Office for National Statistics*.
But what does this mean for businesses and investors? Are companies likely to struggle if anxious consumers are increasingly cautious with their spending?
Pump prices rose more in March than in any previous month on record, despite the Chancellor announcing a 5p fuel duty cut, according to RAC Fuel Watch data** It found the average cost of a litre of unleaded petrol went up by 11.62p to end the month at 163.28p per litre – the largest single month increase ever**.
But owners of diesel cars fared even worse with the average price rocketing by 22.06p-a-litre to end the month at 177.29p**. As of 2nd May, 2022, the average price-per-litre of unleaded is 162.91p, super unleaded 176.13p, and diesel 177.40p**.
Retail sales were also poor for the time of year and sales volumes fell rapidly in the year to April, according to the latest CBI monthly Distributive Trades Survey***.
Sales are expected to remain below seasonal norms in May, with rapid inflation meaning the cost of living crisis isn’t going away, according to Martin Sartorius, the CBI’s principal economist. “To combat these challenges, the government will need to keep a close eye on support for vulnerable households and businesses struggling with higher energy prices,” he said.
George Brown, an economist at Schroders, believes Britain’s economy is on course to contract this quarter and may even end up in a recession.
“Consumer confidence is at rock bottom and households have started to tighten their belts as they begin to experience the biggest fall in living standards since at least 1956,” he said. He also warned that purchasing power is set to be further eroded by higher food and energy prices, due to the war in Ukraine, as well as cost pressures from China lockdowns hitting supply chains.
He also expects a number of other factors to adversely affect Gross Domestic Product during the second quarter. This list includes the government’s decision to end free coronavirus tests. “Vaccination and the testing programmes have been the main contributor to GDP being 1.5% above its pre-pandemic level,” he said.
Another is the Queen’s Platinum Jubilee four-day weekend in June. “A two-day loss to output for many sectors compounded by workers taking off the remaining days that week,” he added.
Ed Smith, co-chief investment officer at Rathbone Investment Management, expects falling real income to continue for some months yet. The UK consumer is “one of the most likely of the major economies” to fall into recession, he believes, citing the dreadful retail sales numbers.
However, he pointed out that the cost of living crisis isn’t the only thing at work here. “We know from the high frequency data that there is a shift in consumer spending from goods to services that’s going on at a pace we haven’t seen before,” he said.
So, where should you invest? Which companies are likely to be affected – either positively or adversely – from a potentially recessionary environment?
There’s little doubt that the last few months have been challenging, according to Simon Brazier, manager of the Ninety-One UK Alpha fund.
He blamed the “exceptionally volatile” UK equity market on the crisis in Ukraine, inflationary pressures and supply side constraints. “Global energy prices are at elevated levels and are not only a tax on the consumer, but they put significant pressure on the cost base of companies,” he said. “We are seeing pricing pressure right across the value chain from agriculture products, fertiliser, steel and shipping costs.”
As far as portfolio construction is concerned, he favours companies that will see revenue and profit recovery as their markets come back in the wake of Covid-19. “We are focussed on maintaining a portfolio of companies with strong balance sheets, that are globally diversified and that can operate well within a low-growth world,” he added.
Companies that have posted disappointing results in recent weeks have been punished by the stock market, according to the latest update from the Liontrust UK Micro Cap fund. It highlighted heavy news flow in March, as many companies with December year-ends report their full-year results in this month.
“This year, with the volatile macroeconomic environment still feeding through to high levels of investor nervousness, earnings ‘misses’ and other disappointments were often met with quite an exaggerated share price reaction,” it noted.
However, there have still been positive results – despite the worrying backdrop – with stocks such as Cake Box Holdings, Bigblu Broadband, and Calnex Solutions all making solid gains. Bigblu Broadband, the provider of fixed wireless and satellite broadband solutions to rural areas, saw its revenue rise 16% to £27m^.
“Recurring revenue rose from 89% to 94%,” stated the update. “Alongside strength in its distribution network, this represents one of the core intangible assets we believe the company possesses.”
Looking ahead, Sid Chand Lall, manager of the IFSL Marlborough Multi Cap Income fund, believes economic uncertainty is likely to be around for a while. “One has to expect inflation to remain a topic for the rest of 2022 and possibly 2023 in some sectors (food and related fuels) and policymakers are still inclined to raise rates to counter this,” he said.
As far as recent editions to the portfolio are concerned, one is fertiliser business Yara, palm oil company MP Evans, and Devro, a maker of collagen casings for the pork industry. “All three are small positions, attractively valued and well positioned for food price inflation, whilst also capable of profit growth without any extreme situations,” he added.
*Source: ONS, 24 April 2022
**Source: RAC, 6 April 2022
***Source: CBI, 27 April 2022
^Source: Liontrust, March 2022