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UK Stocks Face Same Bleak Backdrop Under Next Prime Minister

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A relief rally for UK domestic stocks after Liz Truss quit as prime minister proved short-lived, underlining the country’s grim economic outlook.

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Stocks most sensitive to the local economy — like banks, homebuilders and retailers — wiped out the brief gains that followed Thursday’s news of yet another change in British leader. The FTSE 250 gauge of mid-caps fell as much as 1.5% to extend a year-to-date drop to 27%, with terrible UK retail sales data for September also weighing.

No matter who enters Downing Street next — be it Rishi Sunak or even Truss’s predecessor Boris Johnson — British companies are struggling with surging inflation and interest rates. That’s unlikely to change, even if market volatility calms down under a new leader and after the reversal of Truss’s disastrous mini-budget.

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“We are on the wrong side of a deep and painful recession,” said Peter Chatwell, head of global macro strategies trading at Mizuho International. “I wouldn’t expect UK equities to have a significant bounce.”

Recession concerns are perhaps most evident in banking stocks like Lloyds Banking Group Plc and Barclays Plc, which have slumped despite a likely boost to profits from rising interest rates. Investors are too concerned about the UK’s mortgage-market chaos, a collapse in loan volumes and a surge in defaults instead.

Strategists at Liberum Capital Ltd. say Sunak is the market’s preferred choice, due to his perceived success as Chancellor of the Exchequer during the pandemic. However, some investors see Jeremy Hunt continuing to be more influential than the actual leader.

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“The implications for growth will depend more on whether the current Chancellor remains,” JPMorgan Chase & Co.’s UK Economist Allan Monks wrote in a note on Friday. Hunt has already brought UK yields down and offered some “relative financial and political stability,” Monks said.

At the same time, greater fiscal prudence could actually be seen as a negative for the economy and stocks, with reduced support for household energy bills and the scrapping of an income tax cut likely to put more pressure on consumers. The upcoming corporation tax hike — which Truss wanted to stop — will also dent British firms’ profits.

Still, with the pound expected to keep falling whatever the outcome of the leadership race, some internationally-focused UK companies could benefit. And, with UK stocks trading at around a 40% discount to the MSCI World index — an all-time low — they could entice foreign bidders. 

“UK assets are inexpensive, and we expect a wave of M&A,” Jefferies strategist Sean Darby wrote in a note to clients on Friday. 

—With assistance from Michael Msika, Allegra Catelli and Joel Leon.

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