Rachel Reeves and the Bank of England cannot change the long course of history

Telegraph

4 hours ago

Questor is The Telegraph's stock-picking column, helping you decode the markets and offering insights on where to invest.
The economy's near-term outlook remains highly uncertain. Although GDP growth surged to 0.7pc in the first quarter, which was up from an expansion of 0.1pc in the prior period, recent interest rate cuts are likely to take many months to have their full impact on the economy due to the existence of time lags.
When combined with the potential for sticky inflation over the coming months, as well as the possible ill effects of higher costs for businesses caused by changes to employer National Insurance contributions, investors may naturally seek to avoid UK-focused stocks.
However, in Questor's view, the long-term return prospects for UK-listed companies are highly appealing. Crucially, an uncertain near-term economic outlook means they trade on low valuations which in many cases are significantly below their intrinsic value.
This provides scope for significant capital gains, both from upward re-ratings as investor sentiment gradually improves, and as a result of a faster pace of earnings growth as the full impact of monetary policy easing becomes apparent.
Indeed, history shows that GDP growth and the stock market's performance are cyclical. Even though various chancellors and investors have previously claimed otherwise, often during periods of economic expansion and bull markets, the economy and equity markets are inherently boom-and-bust entities that simply refuse to go in one particular direction ad infinitum.
Just as interest rate rises between 2021 and 2023 led to a stifling of economic activity, and acted as a drag on company profits, thereby prompting relatively downbeat stock market performance, the current period of sustained monetary policy easing is highly likely to do the opposite.
Investors who are able to look beyond short-term economic uncertainty to a period of relatively fast-paced growth and buy shares that are grossly undervalued, are therefore likely to generate high returns over the long run.
Of course, stocks purchased amid the current challenging economic climate must be able to ride out short-term difficulties in order to produce high capital returns in the long run.
Companies with solid financial positions are well placed to do so, with modest levels of debt as a proportion of net assets and generous headroom when making interest payments from operating profits likely to be key considerations for investors.
Sound finances also provide scope for a business to reinvest in its operations in order to strengthen its market position for the long run. A solid balance sheet may further allow it to make acquisitions that bolster its financial prospects as the economy's performance gradually improves.
Companies that benefit from having a competitive advantage may also be in a relatively strong position to overcome prospective near-term economic difficulties.
A solid competitive position may, for instance, be derived from having a significant amount of brand loyalty that means customers are more likely to reduce spending elsewhere before cutting back on their consumption of a specific company's products.
Lower costs vis-à-vis rival firms also equates to a competitive advantage. It allows for price cuts that enhance the appeal of a company's products amid a challenging financial period for consumers.
A strong competitive position further bodes well for a firm's long-term financial and share price performance. For example, it may enable a company to build its market share during an economic downturn, thereby allowing it to occupy a stronger position through which to capitalise on rising demand as the rate of GDP growth improves.
Clearly, it is impossible to state exactly when the economy and stock market will deliver consistently strong performance. Indeed, it may only become clear after the event, when multiple quarters of strong GDP growth and attractive share price gains have already been posted.
Therefore, it may be logical for long-term investors to seek to move ahead of the curve in terms of buying shares in high-quality companies at attractive prices while their peers continue to do the opposite.
While this may entail paper losses in the short run, a willingness to go against the investment herd has proved to be a highly worthwhile approach in the past. In Questor's view, it is likely to remain so over the coming years.