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UK Equity Market Comment

5 May 2010

Come this Friday, 7 June 2010, we will know the outcome of arguably the most important UK election,
either a hung Parliament or a weak Tory working majority - my money is on a weak Tory working
majority. However, I am neither a politician nor a political expert but either outcome would mean
another general election within 12 – 18 months although tactically, the best timing would be when the
Labour Party starts ripping itself to shreds; probably more destructively than the Tories ever did.
Interestingly, this would provide the LibDems with a realistic chance of confirming their electoral
credibility and possibly displacing the Labour Party as the socialist left of centre party. As mentioned
earlier, I am no political expert but the LibDems have an innate ability to shoot themselves in the foot
and fail to capitalise upon opportunities, so watch this space.

Whether we like it or not politics will be the main driver behind what equity capital markets are likely to
do until there is a Government with a working majority.

Chart: FTSE100 & FTSE AIM All Share 4/1/2000 – 4/5/2010

Source: Intellisys

It is pleasing to note the steady change in opinion concerning Gordon Brown. I have always believed,
indeed stated, that Gordon Brown would go down in history as one of, if not, the most incompetent
Chancellors of the Exchequer.

Gordon Brown inherited not only an economy that was recovering from recession but one with
government finances, like inflation, firmly under control. However, from day one, he and his cronies

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systematically but stealthily set about destroying the economy, starting with everyone’s pension in their
maniac desire to create their socialist utopia – note the television comment from ‘master’ Nick Clegg,
who stated that even he could claim working tax credit!

Government departments, and the mushrooming Quangos, had mindboggling sums of taxpayers’
money thrown at them but with no discernible benefit apart from the concealing of the steady erosion of
this country’s industrial base due to the proliferate growth in bureaucracy and inefficiency. And as with
all Labour governments, the tax system became ever more unfair and complicated benefiting only tax
consultants, accountants and lawyers. Government debt and budget deficits widened while reserves
dwindled, such that when the hurricane-like synchronised global recession hit the UK, it wreaked
immediate and substantial damage to an already enfeebled economy. The UK was one of the first
G7/G20 economies to go into recession and one of the very last to emerge; but has it really emerged
from recession?

We maintain our view that the closest parallel to this recession was that of the 1970’s asset bubble and
oil (commodity) shock induced recessions because all the same actors are there, the only difference
being the presentational changes to their names, e.g., secondary banks read investment banks. It is
also interesting to note that the Bank of England launched a ‘lifeboat’ to rescue the banks with National
Westminster almost going under and 30 odd years later Royal Bank of Scotland (owner of National
Westminster) repeats history.

Moreover, Brown’s economic and monetary policy decisions were late and smacked of indecision and
panic. The economy entered the recession with a tight and tightening fiscal policy, monetary policy was
overly tight because the Bank of England was concentrating upon a defeated enemy (inflation) and did
not, except for one member of the MPC Danny Blanchflower, see the emerging twin dangers of bursting
asset bubbles and commodity shock induced recession and deflation until the recession hit like a
hurricane. Nevertheless, the Government blithely racked up more debt while not easing fiscal policy.

Nevertheless, whatever the outcome of the election, all parties are agreed on one point – the budget
deficit must be reduced substantially and ideally eliminated within one full Parliamentary term. In short,
all government spending will be cut! It is only the timing of when the cutting starts, and where and how
deep the axe falls.

Interestingly, both the Tories and LibDems agree that a big chunk of the budget deficit can be cut
through reducing waste. However, intuitively most people in the private sector, whether they understand
the dark and mystical world of public sector accounting, would feel that wastage figures bandied about
are very much on the low end of expectations. Why? The Brown Administration in typical socialist
fashion threw more and more money at problems thereby embedding inefficiency whereas the private
commercial sector does the opposite and sets very demanding investment hurdle rates to maximise
returns and constantly seeks greater value from every pound invested. Therefore, the potential scope
for efficiency savings is multiples of what the professional politicians could conceive. This is not difficult
to believe when it costs more to distribute tax credits and benefits than the actual sums distributed.
Further savings could be readily achieved through radical simplification but fair reformation of the
personal and corporate tax system.

This brings us neatly to the next Chancellor’s first – emergency – budget, which only implements the
immediate manifesto commitments. However, a comprehensive spending review will be immediately
started and the various findings systematically leaked into the public domain well in advance of this
November’s pre-budget statement, which will enable capital markets to price in investment risk and
identify winning and losing sectors.

Nevertheless, the economy, like consumer confidence, remains fragile and likely to remain so until
there is greater clarity over government spending cuts. Consequently, and despite inflation being above
the Bank of England’s upper rate of 2%, base rate is likely to remain at 0.5% until probably into the first

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quarter of next year. However, a Sterling crisis may not emerge because of the Eurozone problem with
the PIGS economies while US$ needs to remain subdued relative to the main or G20 trading currencies
so that the economy can build up its recovery momentum.

This suggests that institutional portfolios have become predominantly overseas earners and defensively
orientated, and probably likely to remain so for another quarter. Consequently, many well managed and
financed domestic orientated businesses are likely to remain friendless and undervalued, particularly in
the small – medium cap arena. Therefore, we would suggest investors consider taking a contra
investment approach and pick up these friendless companies ahead of the inevitable M&A activity that
will occur and led by overseas competitors seeking to establish a UK base or strengthen an existing
platform for a driven into the Eurozone.

Philip Morrish

E: philip.morrish@intellisys.uk.com

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