iFund- Overview on UK Investment Market (Part 2)

2019-07-25 08:12
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The future relationship between the UK and the EU, including trade and workers mobility, is still uncertain. The market concerns about the negotiation process, especially the impact the global financial centre and the border between the UK and the Republic of Ireland.

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4. Industry

Since the early 1990s, financial and insurance activities accounted for at least 5% of economic output, and 9% in 2009. However, the number steadily declined after the Great Financial Crisis (see Figure 7). In 2017, the financial services industry contributed £119 billion to the UK economy, accounting for 6.5% of economic output.

In the past decade, the UK has maintained a trade surplus in financial services every year (see Figure 8). In 2016, the total value of financial services exports reached 61.4 billion pounds, while the total value of imports reached 10.1 billion pounds and the trade surplus was 50.8 billion pounds. Financial services account for 25% of total UK service exports and 7% of total imports.

In 2016, half of the GVA (Gross Value Added) in the UK’s financial and insurance industry came from London, the major player in the industries. In 2016, the London financial industry contributed £58.2 billion to the London economy, accounting for 14% of London’s total economy.

In the fourth quarter of 2017, employment in the finance and insurance industry reached 1.1 million, accounting for 3.2% of the total number of jobs in the UK. In terms of financial services as of % of total economy, UK ranked eighth among all OECD countries. After from Luxembourg (27%), the UK’s number is close to other top competitors (see Figure 9).

In 2016, 44% of financial services were exported to the EU, and 39% of financial services were imported from the European Union. Therefore, investors should pay attention to the impact of Brexit on financial services. Currently, the EU and the UK are still negotiating on the Brexit program. In fact, many financial institutions have planned to move out or already moved out of UK due to Brexit (see Figure 10).

Figure 7: Financial services sector as a percentage of UK economic output from 1990 to 2017

Source: parliament.uk

Figure 8: Trade surplus in the financial services industry from 2007 to 2016

Source: parliament.uk

Figure 9: OECD countries’ financial services sector as a percentage of GDP

Source: parliament.uk

Figure 10: Companies that have planned to move out or already moved out of the UK due to Brexit

Source: stratfor.com

5. Stock Market

The flagship index of UK stock market is the FTSE 100 Index, a market-weighted index of the 100 most representative blue chip companies on the London Stock Exchange. The index rose from 4,814.30 in December 2004 to 6,754.10 in July 2007, an increase of 40.29%. It subsequently declined 48.76% to 3460.71 in March 2009. However, the index subsequently broke out the previous historical high in May 2013, and then went up again, reaching an all-time high of 7787.45 in 2018 (see Figure 11). Nevertheless, in terms of US dollar, the current index is still far lower than its previous level before 2008.

In terms of valuation, as of June 2019, Bloomberg estimated P/E ratio is similar to the highest level in 2007. However, Bloomberg estimated return on equity have reached the bottom since 2016, implying the market now becomes more optimistic about the UK corporate profitability (see Figure 13). As of the end of June 2019, the top ten constituent stocks accounted for 46.18% of the index weight.

Figure 11: Monthly chart of the FTSE 100 Index from January 2001 to June 2019

Source: Bloomberg

Figure 12: Monthly chart of the FTSE 100 Index from January 2001 to June 2019 (in US dollars)

Source: Bloomberg

Figure 13: FTSE 100 Index Bloomberg estimated P/E (Green Line) and return on equity (Purple Line) from 2005 to 2019

Source: Bloomberg

6. Outlook

From 2009 to 2016, the UK’s GDP growth rate is generally higher than the Eurozone (see Figure 14). However, due to the impact of Brexit, the trend has reversed. In 2016, the United Kingdom launched a referendum on Brexit with 71.8% turnout rate. 51.9% of more than 30 million voters decided to leave the EU. (see Figure 15).

In early of 2018, the Bank of England Governor Mark Carney said that Brexit will cost tens of billions of pounds loss in UK’s economic activity. Bloomberg estimates that if the UK trade with the EU in accordance with World Trade Organization standards for the hard Brexit scenario, UK’s GDP will be less 6.55% by 2030 compared to the scenario that UK stays in EU (see Figure 16). Bloomberg further points out that the hard Brexit will depreciate the currency and cause the inflation rate to rise sharply to 3.6% (see Figure 17).

The UK officially left the European Union at 11 pm UK time on March 29, 2019. However, the parliament repeatedly rejected the Prime Minister Theresa May’s plan, forcing May to resign on June 7. The next prime minister will probably be the former foreign minister, Boris Johnson. He argues that regardless of have deal or not, the UK should leave the European Union on October 31.

The future relationship between the UK and the EU, including trade and workers mobility, is still uncertain. The market concerns about the negotiation process, especially the impact the global financial centre and the border between the UK and the Republic of Ireland.

Figure 14: UK (white) and Eurozone (yellow) GDP growth (YoY) from 2008 and 2018

Source: Bloomberg

Figure 15: Results of Brexit referendum in 2016 (red: Leave; blue: Stay)

Source: Bloomberg

Figure 16: UK’s economy outlook with and without Brexit

Source: Bloomberg

Figure 17: How does hard Brexit affect UK’s inflation (blue line)?

Source: Bloomberg

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