As the UK enters recession, Frédérique Carrier, managing director, RBC Europe Ltd explores the reasons behind the lacklustre performance and examines where investors can find opportunities.

The UK seems to be the first of the major advanced economies to enter recession, and more challenges are in store, as the government announced sweeping spending cuts and tax increases in its Autumn Statement.

The Chancellor, Rishi Sunak’s austerity measures, which are projected to total around 1.9 per cent of GDP over the next five years, aim to get the nation’s debt-to GDP ratio – which stood at roughly 103 per cent as of the end of 2021 – falling at a comfortable pace, Frédérique Carrier, head of investment strategy, British Isles and Asia at RBC Wealth Management said in a statement on Friday.
 
Meanwhile, the Bank of England, the first major central bank to embark on a tightening cycle back in 2021, has raised interest rates to 3 per cent so far. With a more prudent fiscal policy in place, RBC believes that the BoE will be less likely to adopt an aggressive policy going forward and predicts that the bank rate will reach 3.75 per cent at the end of the current tightening cycle, less than the 4.9 per cent consensus estimate.
 
Higher interest rates are already having an impact on the housing market, Carrier continued. In the UK, some 30 per cent of mortgages are fixed for two years and will be coming up for refinancing at much higher rates. Surveys, including a recent one by UK real estate website Rightmove, suggest property prices are declining.
 
With UK consumers particularly sensitive to the housing market, this suggests that the BoE’s efforts are having the intended effect of decelerating demand, Carrier said.
 
RBC believes that decisions taken by policymakers (fiscal recklessness followed by austerity in a recession) and by society at large (Brexit) have put the UK economy on a difficult path. In RBC’s view, the economy will eventually recover, but a change of direction would probably help it improve sooner.
 
Such a change might be happening, Carrier continued. Sunak differs from his three predecessors since 2016 in that he doesn’t seem bent on taking an adversarial stance against the country’s major trading partner, the EU. 

In early November, Sunak became the first Prime Minister since 2007 to attend a British-Irish Council Summit, and a bilateral summit with France has been announced for Q1 2023. A solution to the dispute over the Northern Ireland Protocol, the customs procedures designed to avoid a hard border on the island of Ireland since Brexit, would go some way towards reducing the uncertainty which has affected investment since the UK voted to leave the EU in 2016, in RBC’s view.
 
Low valuations, high dividends
With austerity making economic conditions more challenging, RBC maintains its underweight recommendation for UK equities as part of a global portfolio.
 
However, the bank thinks that there are attractive opportunities in UK equities, which are trading at an historically large valuation discount compared with other markets, even when taking into account differences in sector composition. For income-seeking investors, the FTSE All-Share Index has the highest dividend yield among the major regional equity markets, at over 4 per cent.
 
RBC maintains its strong bias for internationally oriented companies. The valuation multiples of many leading UK-listed multinationals are now significantly lower than peers listed in other markets. Despite their strong outperformance in 2022, RBC believes that energy companies in particular remain attractively valued, given the prospect of oil and gas prices remaining higher for longer. 

Carrier said that RBC would continue to be selective towards domestically focused UK stocks given its cautious stance on consumer spending.