James Lowen, Senior Fund manager at JOHCM UK Equity Fund comments: “The narrative around the cost of living pressures has been unrelenting over the last 2 months – dominating the news and political debate.
“It has also led to a material derating of financials and domestic cyclicals in the UK Equity Market. Our recent article (see here) highlighted the valuation distortions across the market but also the absolute valuation of a number of the stocks caught up in this trend. We concluded many of the valuations are absurdly low.
“We have highlighted consistently over the last 3 months that there are three mitigants to the inflationary cost pressures households are seeing. The first two despite being material and very clear were lost in the debate.
“These were (1) the strong growth in wages, which we expect to grow by c. 5-6% in 2022 – labour markets remain very strong with more job vacancies than people looking for work and with widespread labour shortages this is likely to remain the case into 2023 and (2) around £200-250bn of excess savings build up across the Covid period, which we think will act as a buffer for certain households as we go through H2 2022 and H1 2023. These two items are material offsets to energy and other cost pressures
“The third mitigant we have highlighted is the increasingly likely possibility that the government would come forward and inject another ‘offset’ into the mix. This was not discounted, but happened yesterday. Sunak’s c. £15bn injection into households is significantly more than even we would have expected and importantly is directed at lower earnings groups, which are less likely to have the excess saving and where the inflationary pressures are higher.
“The combination of wage growth and Sunak’s move yesterday means average household free cash flow, available for discretionary spending, will fall only slightly this year, with the excess savings noted above potentially more than offsetting this.
“Consensus – which we see in valuations – is too negative. This was seen in market action yesterday with £ rising and domestic stocks taking a good step off the bottom.”
