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03 March 2003

The UK economy will grow in 2003

For the past two years GDP growth has been achieved primarily as a result of tremendously strong consumer spending.

Mixed results from retailers over Christmas raised fears that the boom was over. Certainly, some stores will have sacrificed margins by starting the sales season early but overall volumes were steady and January trading reports were more encouraging.

The strength of the housing market has undoubtedly encouraged householders to feel wealthier and some equity has been released from this form of saving. Although house prices cannot realistically rise at 25% each year there is still a substantial imbalance between the number of units being created and the demographic requirement for new homes.

Low interest rates have meant the servicing of mortgages has become less burdensome and is encouraging broader home ownership. There are a record number of adults in employment and despite some headline catching job losses there is no reason to expect this situation to deteriorate.

Overall, while it is reasonable to expect a moderation in spending, the circumstances that have driven such strength have not suddenly evaporated.

The shadow of potential conflict with Iraq has created great uncertainty in western economies and stock markets. Nonetheless, anticipated growth in the UK's two main export markets (US and Europe) will complement domestic progress.

After major cost cutting exercises many companies are now more efficient and will be looking to restart delayed capital spending. Together with increased government expenditure, this should restore a better balance to the economy.

The FTSE 100 has almost halved since early 2000. Some sectors were unjustifiably overpriced and have suffered for that but underlying results did not merit such a fall.

In reality, aggregate profits slipped only slightly in 2002 and are expected to grow modestly this year. A few companies saddled with historically high dividend payouts will cut but across the market there will be modest dividend growth.

An indiscriminate bear market does create value opportunities. With a large portion of this year's revenues assured by forward sales and the favourable supply/demand balance, it is anomalous that housebuilders sell at only five times estimated earnings.

A short term reaction to reported weakness in demand for Central London offices has precipitated a widening of the share-price discount to NAV of property companies. This takes no account of long leases that tenants are unlikely to break and the diversity of portfolios by type and location.

Several other sectors including banks and utilities offer attractive yields on low ratings. Private equity providers have recognised the undervaluation of assets by the stock-market and have, for instance, readily funded management buy-outs of several property companies. It is no coincidence that two such financial groups showed an interest in bidding for Safeway.

Ian Anderson
Senior Investment Manager, UK
The Scottish Investment Trust PLC