Rebecca Maclean, Ben Ritchie, Co-Managers, Dunedin Income Growth Investment Trust, Luke Bartholomew, Deputy Chief Economist
There was huge anticipation around chancellor Rachel Reeves’ first Budget at the end of October, as industry, media and markets speculated how she would choose to tackle the purported hole in Treasury finances and boost UK economic growth.
In the event, it proved to be both controversial and complex, with a huge amount of detail to assess and much small print still to be digested. Nonetheless, with the benefit of decent time to study the detail, there are some useful takeaways for UK investors, as the Dunedin Income Growth Investment Trust (DIGIT) team at abrdn explains.
From a macroeconomic perspective, says Luke Bartholomew, Deputy Chief Economist at abrdn, the upswings in spending, investment and taxation should, on balance, result in a boost to economic growth over the next couple of years.
But figures from the Office for Budget Responsibility indicate that growth is likely to fade over the medium term. The OBR predicts real GDP growth of 2% in 2025, falling back to around 1.5% beyond 2028. That reflects the fact that the UK economy is fairly close to full employment, so there is a lack of spare capacity to cope with increased demand.
Instead, the increase in state spending and consequent demand means interest rates are likely to take longer to come down than previously expected; “we are expecting quarterly cuts through 2025”, Bartholomew highlights.
But on a longer-term view, they believe the Budget’s investment plans are less about fiscal stimulus and more about boosting the productive capacity of the economy.
The impact on prices has also been a source of concern in the aftermath of the Budget. The OBR forecasts inflation will remain above the Bank of England’s 2% target to the end of the decade, as Reeves’ fiscal stimulus measures take effect on the UK’s full-employment economy.
Those measures are set to be exacerbated by the introduction of hefty increases in employers’ national insurance taxes, as well as the national living wage threshold. The latter in particular, could push wages up across the board, as other workers and employers seek to maintain existing wage differentials.
The increase in employers’ NI is a particularly difficult measure to assess. “My best guess is that it will largely fall on workers and consumers in the form of lower wages, fewer hours and higher prices,” says DIGIT co-manager Ben Ritchie.
That cost pressure on low-waged jobs could prove an incentive for businesses to invest in automation of some sort or may just result in lower employment; but Ritchie does not expect it to amount to a major squeeze on profit margins.
The counterbalance to rising unemployment, and the route to 2.5% growth, Bartholomew says, is “to free supply-side measures” – most importantly through planning system changes, but also through revisions to industrial strategy, competition policy, energy pricing and trading relations with Europe.
“We’ll have to wait to see whether all that is delivered,” he stresses. “This Budget won’t fix everything, but it’s heading in the right direction, investing in some aspects of long-term productivity growth. We haven’t revised our long-term forecasts up yet but hope to have to do so when those planning reforms start being announced.”
As far as various sectors are concerned, the Budget impacted broadly in tax terms, says Rebecca Maclean, co-manager of DIGIT. “I think we need to consider the detail to understand what it means on an individual sector basis, but certain sectors are seeing some clear incremental positives.”
One, unsurprisingly, is the construction industry, where increased infrastructure spending should bring rewards. DIGIT holds several stocks that operate in that space, including plastic piping manufacturer Genuit, which among other things implements sustainable water management solutions.
Construction services group Morgan Sindall is another holding well positioned for the infrastructure boost. “It currently has a number of customers on the infrastructure side,” Maclean adds. “For example, it’s involved with National Grid in investing in the grid infrastructure in the UK, as a construction partner.”
Home-building is also worth highlighting, with Taylor Wimpey featuring in the DIGIT portfolio. Although the Budget disappointed in its lack of support for would-be buyers, the Labour government has plans to free up the planning system bottleneck.
“We are hearing from housebuilders that they’re already seeing some of that easing in the planning pipeline,” Maclean reports.
A third area likely to benefit from the new government’s growth plans for carbon reduction is electric utilities. She picks out carbon capture storage and green hydrogen projects as of particular interest.
“These are much more long-term projects and again we need the detail to understand what it means in practice, but the announcements have certainly been helpful for these themes,” she notes. DIGIT’s holdings include National Grid and SSE, which are “benefiting from the uptick in investment in the electricity network and transmissions sector”.
Of course, other sectors – notably retail and leisure – are particularly concerned about Reeves’ NI and national living wage announcements.
Ritchie and Maclean expect to hear from companies about how they intend to manage those additional costs: how far they’ll be able to offset them with efficiency gains or pass them on to the consumer.
More generally, says Maclean, “it’s probably going to limit some of the upgrade potential in these sectors as they work out how to manage the costs, but it also comes down to the question of driving productivity and the extent to which companies are able to use technology to improve efficiency.”
In the meantime, the flip side of higher wages for lower-earning and public sector employees is that they will have more to spend, and they may be supporting these businesses in the process.
A key question for DIGIT investors, of course, is how far the Budget has helped strengthen the portfolio’s prospects or, more generally, enhanced UK plc’s position within the global investment arena.
For DIGIT, with its focus on high-quality, resilient companies with sustainable business models and robust cash flows, that can translate into reliable and growing dividend payments. After all, the past couple of years in particular have presented significant headwinds for portfolio businesses.
But as Ritchie points out, the macroeconomic backdrop is finally improving. The UK economy has emerged from last year’s mild recession and GDP is strengthening, interest rates are falling, and there is much less opacity generally over the new government’s plans and targets.
“You may or may not have liked the Budget, but we do now have a much clearer picture of the next four or five years as to the environment that we’re operating in,” Ritchie argues. That clarity, he believes, will stimulate the broad flow of capital into the UK equity market, and more specifically help the companies in DIGIT’s portfolio.
Against that, international geopolitical headwinds show no signs of abating. For Ritchie, international risks underscore the importance of DIGIT’s focus on resilient companies that can do well both in cyclical upturns and in tough times, and that don’t depend heavily on extraneous factors to prosper.
“Looking ahead we see a much more balanced environment for Dunedin Income Growth; we don’t expect hurricane tailwinds, but after the challenges of the past three years we think we’re very well positioned to deliver capital and income growth,” he concludes.
Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.
Listen to the DIGIT Digest Budget special here.
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