🧳 The Great Big Budget That Never Was
It was the Conservatives' final hurrah to impress voters and markets alike with their 2024 budget. However, despite some promising rumours, the overall budget still fell flat.
Hello there! I'm John Choong, Senior Equity Research Analyst at InvestingReviews. Every week, I dissect the latest stock market news, macroeconomic data, and even drop a share tip or two. Join me, as I dig into the financial world's nitty-gritty.
🗞️ This Week’s Highlights
📕 Budget summary: A British ISA was announced alongside a further 2% cut to national insurance for full-time employees. Regrettably, though, industries desperately in need of a boost were neglected.
🛍️ A neglected retail industry: With business rates having been on a constant rise since 1990, retail seems to be one of the only industries that isn’t very conservatively run by a Conservative government.
✈️ May the good times keep rolling: Rolls-Royce has experienced one of the stock market’s most monumental comebacks over the past two years. Whilst some analysts are calling for a top, this seems unlikely given industry trends.
📊 Markets This Week
📈 FTSE 100: 7,661 (↓0.64%)
🇬🇧 FTSE 250: 19,594 (↑1.31%)
🧾 5-Year Yield: 3.932% (↓0.64%)
💵 GBP/USD: $1.29/GBP (↑1.60%)
🎟️ Rolls-Royce: 387p (↑3.14%)
📕 Budget summary
This week’s budget was not a blowout by any means with no real economic growth drivers. But given the historical context of post-budget fallout, one could reluctantly say that this one was a 'success'. A 2% cut to national insurance isn’t too shabby, but the overall budget still fell short with a lack of tax cuts, no real initiatives to help housebuilding, and nothing much to boost a struggling retail industry either.
As I had alerted to in my previous newsletters, there was always going to be limited headroom for Hunt and the Conservatives to do much anyway. This was especially the case if the chancellor opted to follow the OBR’s guidance and economic projections, which left less room for tax cuts and other initiatives.
Given how unlikely the Conservatives are to win the upcoming election, it does make you wonder why they didn’t just take a punt, though. But like I alluded to last week, Hunt is a technocrat, and was always more likely to play puppet to the OBR than to do anything innovative. Which then begs the question of whether the chancellor even serves a purpose at this rate.
After all, the OBR are by no means experts either. Aside from the fact that they’re not even elected to begin with, they’ve also gotten their economic forecasts terribly wrong over the past few years. So who’s to say that the limited ‘headroom’ that was ‘given’ to Hunt is even reliable to begin with anyway? Renowned journalist Andrew Neil had a few choice words, and made an excellent point.
“The idea that this year’s fiscal decisions in the Budget should be determined by what the OBR thinks national debt as a percentage of GDP will be in five years time is frankly ludicrous. No other major advanced economy does its budget this way. The blunt truth is that the OBR has no idea what our debt to GDP ratio will be in 2029. It doesn’t even know for sure what it will be this financial year.”
Either way, you can’t blame Hunt entirely either. The nation is still shellshocked by the aftermath of the Truss mini-budget that occurred only a year and a half ago. Therefore, this was a budget to appease the bond market rather than voters, and not cause another meltdown. Though, it’s mind-boggling that the livelihoods of many are in the hands of traders and big corporations. Money talks, I suppose.
Still, the good news is that the bond market took the budget well as gilt yields ended the week below their recent peaks. But perhaps more importantly, the all-important 5-year gilt yield is heading back in the right direction, hitting a one-month low.
Nonetheless, my eyes were most drawn to the British ISA. ISA holders now have an extra £5k to spend on British securities. Unfortunately, this seems more symbolic than anything. Given that only c.15% of ISA holders max out their current £20k allowance, as pointed out by the wonderful Merryn Somerset Webb, the extra allowance won't be meaningful enough to boost UK share prices.
Quite how the government decides to implement this is still up in the air. There are questions as to whether this will be added onto the current Stocks and Shares ISA allowance, and whether the £5k allowance will just be for UK equities or will it include UK gilts as well. All will be known come 6 June.
But one thing’s for sure — it isn’t going to help the UK market rerate tremendously (or at all). Yes, the £5k allowance will help ever so slightly, but retail investors don't move markets, big money does. If we want volumes and interest to return, we'll need incentives for foreign capital to flood back into our market, especially when funds continue to flow out, month after month.
PLCs are getting swooped up on the cheap too. This week, Spirent and Virgin Money have been just two of the latest getting acquired by private companies. This leaves the UK market drying up with not enough IPOs to replace those getting bought out. Hence, I reiterate my stance that the government needs to cut its ridiculous 0.5% stamp duty if the UK market wants to find its footing again.
🛍️ A neglected retail industry
Despite calls from business leaders like Marks and Spencer CEO Stuart Machin for the government to spare the retail industry from further rises in business rates, it’s unfortunate to see the industry continuing to get neglected.
To summarise the debacle, business rates are a form of property tax that is charged to retailers with properties. These rates are calculated based on a property's rateable value. Indeed, retailers owning or renting large stores, warehouses, or offices may have exponentially higher business rates which can take up a substantial amount of their bottom lines.
As business rates increase, they add more financial pressures on retailers. As such, high-street retailers are struggling to grow their businesses having seen their rates climb year after year while margins and volumes get squeezed due to higher costs and a plateau in tourism. For context, business rates started off at 35% when it was first introduced in 1990, and has sky-rocketed to a whopping 51.2%.
This could drive businesses into unsustainable territory. It’s for this reason that business leaders wrote an open letter to the chancellor to adopt a more forgiving increase of closer to 2%, than the 6.7% proposed. Legislation states that business rates are to increase in April by September’s CPI rate.
A proposal to scrap the ‘tourist tax’ where tourists could claim VAT refunds wasn’t present at the budget announcement either, unfortunately. This comes at a time when the industry is in desperate need of foreign capital, as high-wealth customers flock to European cities to shop instead, leaving home brands like Burberry in a mess.
Pair the above with poor retail sales data since December, and it should be no surprise that most retail stocks have performed so poorly this year.
Recent data from BDO and the BRC showed very gloomy trends, with the former citing a fifth consecutive month of negative volumes since November. This week’s BRC data didn’t do much to dispute this either, with non-adjusted inflation sales growing only by a measly 1.0% and missing consensus estimates of 1.6%. Given that shop price inflation currently sits at 2.5%, volumes remain negative.
And although data from the ONS showed retail sales volumes bounced back by quite a bit in January, this only served to compensate the massive drop off from December, as volumes since November remained flat. Thus, if retailers are to bounce back from their lows, it’ll have to come in the form of positive real incomes, improving consumer confidence, and better weather, although we remain bullish on the industry.
✈️ May the good times keep rolling
Rolls-Royce (LON:RR) continues to climb like the sky’s the limit. In spite of the tremendous 669% rally from its bottom leading up to this year, the stock is still rising. In fact, the shares are already up 30% this year, begging the question of whether there’s more upside to be realised. Our answer? Yes.
Many investors fear buying shares at a high due to the potential downside risks. However, given the upside potential to the engine manufacturer’s earnings over the medium term and its forward multiples still looking reasonable, we see continued growth to be realised given the conglomerate’s multifaceted business model.
Rolls runs three main business operations — Civil Aerospace, Defence, and Power Systems. With CA still catching up to pre-pandemic levels and travel incredibly robust (and still growing), we see more growth in the pipeline. As for Defence, governmental spending ensures steady revenue growth, while Power Systems continues to provide excellent energy solutions to clients at a healthy growth rate.
This investment thesis was confirmed when the company disclosed its latest FY23 results. Not only did Rolls’ top and bottom lines jump, so did its margins. Most crucially, however, it’s also paying down debt, with new CEO Tufan Erginbilgic getting the business in shape. As a consequence, net debt is now down to £1.95bn from £3.25bn last year.
More promisingly, Erginbilgic upgraded the group’s outlook for the medium term as well. He now expects free cash flow to come in at a staggering £1.7-1.9bn, up from last year’s £1.29bn, with an underlying operating profit range of £1.7-2.0bn.
Taking industry trends into consideration, such as flights to and from Asia (Rolls-Royce’s main driver for revenue growth due to long-haul flights), and tailwinds are picking up for the engineer.
Furthermore, governments are pledging to spend a bigger percentage of GDP on defence. With Rolls-Royce being one of the biggest players for NATO countries in providing defence solutions through submarine and jet fighters, they’re set to gain billions in contracts as well.
What’s more, its often overlooked and under appreciated Power Systems arm stands to benefit vastly from a world that’s increasingly pivoting towards greener modes of energy.
As a result, we see an excellent growth runway for the FTSE 100 stalwart. Currently, we’re projecting earnings growth of c.16% in FY24 with EPS estimated to grow by c.45% by FY26. This, therefore, puts Rolls-Royce shares in a comfortable position, where its share price keeps up with earnings growth. Consequently, we issue a Buy rating with a price target of 430p.
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🔎 What to Watch Next Week
👩🏼💼 Unemployment Rate: With the revised labour force survey pushed back to September, economists and analysts will have to rely on shoddy provisional figures till then, as the participant pool for the data remains poor. Unemployment is looking to come in flat at 3.8%, but take this figure with a pinch of salt.
💸 Average Weekly Earnings Growth (inc. Bonus): Markets don’t see average earnings growth moving by much, at 5.7% from 5.8%, after a sharp fall in the three months to December. But the devil will be in the details, as any hopes that second-round effects come April/May won’t push CPI back above 2% will be heavily reliant on the three-month annualised figure easing further from 2.2%.
💷 GDP (M/M): Investors alike will be hoping that there will be the first indications that the UK pushed itself out of a recession as soon as it dipped into it. Consensus sees January GDP growth of 0.2%.
🏠 RICS House Price Balance: Further indications that the housing market is rebounding will be looked out for. If the final print comes in above last month’s read of -18%, or above consensus of -15%, housebuilder stocks could be in for another ride upwards, as it would make the sixth consecutive month of rebounds.