U.K. Looks Like a Basket Case, But Markets Haven’t Lost Faith Yet

It’s increasingly easy to present Britain as a basket case.

This might not sound like a natural place to invest, and indeed

Deutsche Bank

this week flagged up the (small) risk of a balance of payments crisis. But everything has a price, so it’s worth at least wondering if the U.K. is cheap enough to more than justify the obvious weakness.

My view is that Britain has much the same troubles as the rest of Europe, thanks to soaring energy costs in the wake of Russia’s invasion of Ukraine. It’s made things a bit worse for itself by taking a holiday from government while the Conservative Party picked a new leader (who said some silly things about managing the economy) over the summer, but it can rescue the situation.

It’s easy to cherry-pick data to support the case that markets are losing faith:

Sterling on Wednesday dropped below its 2020 low against the dollar to reach the lowest since 1985, and there’s loose talk in the markets of “dollar parity” (though at $1.14 to the pound even 1985 low of $1.05 remains far off).

• Gilts have sold off heavily, with August the worst month for 10-year and 30-year government bonds in data back to 1989. Investors took fright at the prospect of Ms. Truss’s new government having to borrow well over £100 billion, equivalent to $115 billion, to cap energy prices, as well as her promise to cancel planned tax increases on companies and workers.

• Stocks have been an absolute disaster for a very long time, with the price of the FTSE 100 barely up since its 1999 peak, and the forward price-to-earnings ratio dropping below 10 this summer, the cheapest of any large market. A dollar-based investor would have made no money since 2014 in the FTSE, while more than doubling it in the S&P.

It’s equally easy to dismiss such price moves. Sure, the pound has collapsed against the dollar. But what currency hasn’t? The pound is down about 15% against the dollar this year, but the euro is down 13% and the yen 19%. Sterling is no outlier. The same goes for gilts, which lost slightly more than German bonds at all maturities; enough to notice, but a 3% yield on the 10-year is hardly a sign of panic with inflation at 10%.

British small and midsize companies, which tend to be more domestic, have underperformed European ones this year, but again not by much. And the FTSE itself has beaten both European stocks and the S&P 500 in dollar terms—and is rare among equity markets in delivering a positive return when its dividends are included, in local currency terms. The sub-10 price/earnings ratio on the FTSE was a result of the skew of the market toward energy and mining companies, which have low valuations everywhere, not just in the U.K.

The markets haven’t—at least so far—concluded that Britain has unique troubles.

Yet, the risk of a crisis can’t be dismissed.

Julian Jessop,

a fellow at the free-market think tank Institute of Economic Affairs and an informal adviser to Ms. Truss’s campaign, says problems are possible. The U.K. has a record current-account deficit and needs to borrow more to finance her plans, at a time when the government has yet to establish credibility.

What could make it go wrong? “If she comes out and does something completely bonkers then that’s a threat,” Mr. Jessop says. A deep recession forcing yet further tax cuts would hurt. Or if a series of policy reverses make the markets lose faith in Britain’s predictability, when the world economy and markets are already highly volatile. He doesn’t expect any of these.


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Ms. Truss’s inflammatory comments during the internal party election campaign over the summer mostly explain the underperformance of British markets compared with Europe. But her musings about changes to the Bank of England and her praise for the

Bank of Japan

—which has the easiest monetary policy of any major central bank—are unlikely to lead to radical changes. If anything, she seems to want tighter policy, which foreign investors would applaud. Equally, her rejection of “handouts” followed by reports of different ideas for energy rescue plans confused investors.

Hopefully, the new prime minister has learned from the market reaction to her comments and will improve her communication. The first test comes on Friday with details of her plan to cap energy bills.

Britain, like Europe, faces hard times, and isn’t coping terribly well. But its institutions still function and markets haven’t, for all the scaremongering, lost faith. Things could always get worse—or be messed up by an inexperienced government—but I wonder if the apocalyptic talk is itself a sign that pessimism about British assets has gone too far.

U.K. Prime Minister Liz Truss outlined her economic agenda in her first speech from Downing Street, after meeting with Queen Elizabeth II in Balmoral, Scotland. Earlier in the day, Boris Johnson defended his legacy in final remarks before officially resigning. Photo composite: Eve Hartley

Write to James Mackintosh at James.Mackintosh@wsj.com

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