Government spending cuts offer opportunities for some.
It looks very likely that Gordon Brown is going to call an election early in March (certainly by May) but, regardless of whichever party wins the election, there is going to be an unprecedented squeeze on government spending over the next few years.
Still, if the UK does suffer post-election blues, it won't be all bad. Although many companies could suffer, some stand to do quite well out of it. The trick, of course, will be to pick them!
Which sectors will suffer?
The question is which sectors are likely to suffer as a result of Government efforts to reduce expenditure? The sectors that are likely to feel the most immediate impact from these cuts are likely to be those with exposure to public infrastructure projects (roads, schools and hospitals), the NHS and defence spending. So the FTSE sectors most affected could include:
- construction and materials;
- support services;
- aerospace and defence; and
It would be a mistake to write of all the companies within these sectors though, as the picture isn't clear cut and will depend on which niche within these sectors a business operates in, as well as its overall exposure to the UK economy.
Moreover, if cuts in public expenditure lead to increased unemployment and hampers economic growth, the negative effects won't just be confined to companies in these sectors.
I reckon a stagnant economy, with rising taxes and unemployment, will be very bad news for general retailers and stocks dependent on consumer confidence and discretionary advertising spend, such as media companies.
Winners and losers
In the construction sector Keller Group (LSE: KLR) has a great track record of increasing dividends but may be one to be wary of, as a large proportion of its revenues are generated from public infrastructure projects that will be affected when stimulus packages end.
Both Costain (LSE: COST) and Balfour Beatty (LSE: BBY) have been doing well but do have significant exposure to areas that could be hit by government spending cuts. However, Balfour Beatty also generates a significant amount (30%) of its turnover from the US, which may emerge from the downturn long before the UK. Despite all this, some people see construction as an attractive area, due to low valuations.
In support services, Spice (LSE: SPI) has already seen half-year results affected by increased competition and reduced capital projects in its gas social housing business, which necessitated a one-off charge. It consequently made a pre-tax loss of £31.5m for the half-year. However, its share price drop looks overdone to me.
Babcock International Group (LSE: BAB) would be my pick from this sector though, due to its resilience under present market conditions.
In his Pre Budget Report, the Chancellor signaled that there will be significant cuts in Government IT spending, with £500m removed from the annual spending "from reducing spend on IT, including by reducing the cost and scope of the NHS IT programme".
There is every likelihood that this will benefit companies such as Capita (LSE: CPI), which is already the number one provider of business process outsourcing to UK central government, and rival Serco (LSE: SRP).
Impact on gilts
Gilts have been flooding the market to pay for the public debt incurred in saving the banks and pumping up the economy. They have largely been mopped up by the policy of quantitative easing. If this prop to the economy is withdrawn too suddenly, before the economy is growing healthily, we're likely to see sterling take a nosedive, along with the price of gilts.
If that happens a vicious cycle may ensue. Gilts will have to offer higher rates of interest in order to attract buyers, meaning the cost of government borrowing will increase. The markets will want to see the UK has a clear plan of action to reduce its debts. Spending cuts could be deeper and coupled with further increases in taxation.
All of this means that stock picking will be as important as ever in the years to come.
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