In our global dividend portfolio, we hold a variety of international stocks including a sizeable number of holdings domiciled in the United Kingdom. Recently we have made concerted efforts to reduce our exposure to the United Kingdom. We sold some of our U.K.-based stocks including Sky PLC (SKYAY, Financial), and reduced our exposure to the holdings we kept (listed below). The companies we kept do not have an overly large exposure to the U.K. market or British pound. For example, oil is priced in U.S. dollars, so there is little currency risk in the energy holdings. Glaxo’s largest market (by country) is the U.S., so it earns substantial revenue in dollars, likewise for Pearson.
- GlaxoSmithKline (GSK, Financial)
- Pearson PLC (PSO, Financial)
- Imperial Brands (IMBBY, Financial)
- British American Tobacco (BTI, Financial)
- BP PLC (BP, Financial)
- RoyalDutchShell (RDS.A, Financial)
- Unilever (UL, Financial)
The reason why we’ve reduced our exposure to the U.K. market has to do with the economic policy being pursued by Prime Minister David Cameron, Chancellor of the Exchequer George Osborne (roughly the UK equivalent of our Secretary of the Treasury) and the Conservative Party.
Macroeconomic troubles are ahead for the U.K.
The U.K. Conservative party throughout Cameron’s tenure as prime minister has had an obsession with balancing the budget. Cameron made numerous cuts to the budget in 2011, which led to a brief two-quarter double-dip recession in 2011 to 2012 (it was subsequently revised away). Whether or not it technically met the definition for a recession (two consecutive quarters of negative growth) is immaterial. As the chart below shows (highlighted by a red box), the economy noticeably weakened under Cameron’s austerity measures.
The “double dip recession” forced Cameron and the Conservative party to rein in their budget cuts and the British economy once again returned to growth. After this return to growth we figured Cameron, et. al. had learned their lessons, but alas we were wrong.
Cameron and Osborne are now making a renewed effort to balance the budget and proposing an additional ÂŁ4 billion in budget cuts over the next four years. The budget deficit is projected to drop from around 3% of GDP now to just 1% by 2018.
By now it should be obvious that cutting government spending during a period of low private sector growth is a recipe for economic stagnation or a recession. We’ve seen it happen all throughout Europe where austerity measures have pushed economies to stagnation, or in Greece's case, a depression. Cameron and the Conservative Party seem bent on recreating the 2011 to 2012 “almost double dip recession” yet again. However, the problems in the U.K. don’t stop there.
Household debt trends are alarming
One of the more alarming trends is that U.K. households are responding to the government’s effort to reduce its debt by increasing their debt. The chart below shows U.K. household debt as a percentage of income compared to various other countries including the U.S.
We can see that not only are U.K. household debt levels still some of the highest in the developed world, but they are increasing and projected by the U.K. OBR to reach levels close to their pre-recession peak later this decade.
What we are starting to see in the U.K. looks an awful lot like the pre-recession household debt bubbles we saw in the both the U.S. and U.K. prior to the Great Recession. Back in the late 1990s and early 2000s, Bill Clinton attempted to do exactly what Cameron is now attempting and balance the budget. As we can see in the graph below, the government’s attempt at balancing the budget lead the private sector to increase their borrowing.
Households in the U.S. went from net savers to net borrowers. It’s a simple accounting identity. When the government moves to a surplus and starts removing net financial assets from the economy, either the private sector must move into a deficit, or the foreign sector (trade) must be a surplus. Like the U.S., the U.K. runs a trade deficit so that leaves only one option to bring the sectors into balance. The private sector must move to a deficit is the government sector is to run a surplus. As we’ve written many times before, the national debt is nothing to be afraid of and the government sector should almost always be running a deficit in order for an economy to be healthy.
Summary
The foolish macroeconomic policy being pursued by the U.K.’s ruling party have forced us to significantly pare back our exposure to the country. We believe investors, especially U.S. based investors, are better off searching the U.S. stock market for bargains. The U.S. is set to benefit from a very modest fiscal stimulus over the next two years versus the budget cuts and declining deficit in the United Kingdom. The macroeconomic backdrop for U.S. companies is superior to the U.K.
