UK needs to get serious about supply side – FT Adviser

While UK equities have been trading on less than 10 times their predicted earnings, the US has been trading on 12. So far, the UK’s stockmarket rating has been affected more by the eurozone crisis than the US’s, due in part to the eurozone’s proximity to the UK. But if the US’s rating nears the UK’s due to eurozone contagion, current dynamics will make it a better long-term relative bet.

The reason is that while the US and the UK both house plenty of international businesses, the macroeconomic outlook for US domestic stocks is much better than that for the UK. The US’s advantage can be summarised in one word: onshoring. As Giles Hargreave, top-performing UK equity manager, pointed out in our interview with him last week, onshoring is a key potential source of growth in the US, both for companies and for the economy. The UK, by contrast, is worse positioned to benefit.

The outlook for onshoring is speculative, but can be summarised as follows. In the 1970s, domestic, onshore production in Anglo-Saxon economies became extremely expensive. In terms of natural resources, the US in particular became increasingly dependent on imports from overseas as boosting production became more difficult and more expensive.

In both countries, manufacturing labour also became very expensive, stoking a vicious inflationary spiral. As emerging markets entered the global economy, the US, the UK and other developed world countries outsourced production to these cheaper stores of labour and commodities.

In recent years, however, the competitive advantages of emerging markets have waned. Resource producers remain politically unstable, and prices have stayed elevated. Manufacturing in emerging markets has become increasingly expensive, particularly on the Chinese coast. Building infrastructure to shift production to inland China, Indonesia or frontier markets could take years, if not decades.

With its flexible labour market and shale energy reserves, the US is well positioned to onshore production, which will boost the domestic economy and could even help boost the dollar. The dollar’s status as the world’s key reserve currency will also help mitigate – although perhaps not prevent – the brewing crisis in US government finances.

The UK, by contrast, has fewer trump cards to play. It has North Sea oil and gas, but these are less easily recoverable, and the UK hiked taxes on energy producers to unsustainable levels last year.

The UK is also more directly embroiled in the eurozone crisis and is vulnerable to any new EU labour legislation, which tends to be less flexible than in the US.

One obvious area of opportunity the UK has over the US is a constrained supply of property in a larger proportion of the country – but so far the coalition has not managed to reform planning laws to allow a greater volume of sustainable development.

Until the UK gets serious about supply-side reform to its economy, the US stockmarket will justify higher valuations with ease.

Nick Rice is editor of Investment Adviser