HAMISH MCRAE: Onwards… after a tough year

It has been a difficult year – indeed one of the toughest for investors, businesses, and for families that most of us can recall. It was always going to be difficult because it was pretty clear that the central banks were underestimating the danger from inflation. 

My own pick for investment, gold, was based on fears that inflation really would get of control. 

Of course, I did not foresee the additional blow from the invasion of Ukraine and the horrors of that. But, actually, while gold has proved a decent return for sterling investors, in dollar terms it is a tiny bit down. Even the classic safe haven has not proved to be that safe. 

Flying the flag: Even if the UK remains unfashionable, there will be some revival in both equity prices and sterling by the end of this coming year

The conventional market view now is that 2023 will be just as tough, maybe tougher. There are the rumbles of recession, where the debate is about how long and how deep it will be for the various economies. The UK is firmly in the dog house, with economists sneering at our supposed underperformance and wondering how much to attribute that to Brexit and how much to something else. 

If the figures are duly revised upwards in a few years’ time, as they usually are, they will doubtless find something else to worry about. (For the record, I would acknowledge that we do have a problem over our productivity, which is the flipside of the economy’s extraordinary ability to create jobs. But that is not particularly related to Brexit.) 

So the challenge for us this coming year is to gauge which elements of this conventionally gloomy view are justified, and which will turn out to be as wrong-headed as the features of a year ago look now. For example, the adulation of high-tech US companies, negative interest rates in Europe and the whole crypto-currency universe. 

Well, there certainly will be a slowdown, here and elsewhere. There will be technical recessions, as defined as two successive quarters of negative growth. In plain language, that’s six months of economic activity shrinking. 

The interesting questions are about the nature of the recession, assuming it does indeed happen. Maybe the bits that shrink had become overblown. 

There are stories just coming through from New York of Goldman Sachs sacking 4,000 people, and of other Wall Street job cuts. Twitter, Facebook and other hightech enterprises are downsizing too. But maybe they didn’t need those people in the first place. Maybe a lot of what they were doing produced no social benefit.

It is tough for individuals who get caught up in the recession, but much of the adjustment is simply getting rid of activities that did not need to be done.

If this is right, the UK may come through next year in rather better shape than conventional wisdom expects. At the moment, unemployment at 3.7 per cent is still nearly the lowest since 1974. The housing market has come off the top and that is welcome, but it has not crashed. Services that have been particularly hard hit by rising costs, including the hospitality industry, are learning to streamline their operations and offer a decent service at lower costs. 

It is controversial to say so, but I do not think that interest rates in the UK will need to move up as much as the markets currently expect. The Bank of England was quite right to raise rates to 3.5 per cent last week. However, my guess is that the top will be 4 per cent, rather than any higher, and that inflation will come down quite sharply next year. 

There are investment implications in all this. 

As the froth is blown away, the hunt for value intensifies. UK shares remain undervalued by US and even by European standards. The FTSE100 is down 2 per cent on the year to date and on a price/ earnings ratio of around 14. 

The S&P500 is down 20 per cent but still on a p/e of nearly 20. You get double the dividend yield here too. Much is made of the UK market representing old industries, including banking, oil and mining, whereas the US is dominated by high-growth ones. But maybe in tough times we need financial services, energy and raw materials more than we need Twitter and Facebook. 

My conclusion is that UK assets will benefit partly because of bottom-fishing (foreigners buying UK companies on the cheap) but also because of this wider hunt for value. So even if we remain unfashionable, and I think that the negativity has gone to ridiculous lengths, there will be some revival in both equity prices and sterling by the end of this coming year. Indeed, I could see the pound back to $1.50, though that may take a while yet.