Threadneedle: BP could be event that stalls recovery

Threadneedle’s head of UK equities Simon Brazier warned the Gulf of Mexico oil spill has the potential to derail the economic recovery and could have a severe impact on the oil sector.

The former manager of the Schroder UK Equity fund, who joined Threadneedle in March, anticipates that the spill will lead to tighter regulation in the sector, creating higher costs for oil companies that could ultimately feed through to higher oil prices.

Brazier uses the tightening of regulation in the North Sea following the Piper Alpha oil spill in 1988 as an example of what could be in store for the sector.

‘No doubt BP will send shock waves through government bodies regulating oil and companies will have to make sure they have got everything certified, which means rising costs. There is a risk that this will feed through to higher oil prices, which is a dampener on economic growth,’ he said. ‘Some companies will be well positioned for this. For those that operate in the North Sea, there will not be large cost implications. Regulation is only going one way: it is getting tighter and stricter.’

Brazier is also concerned that the spill will make other companies more risk averse to undertake complex exploration projects, which could reduce supply and act as another upward pressure on the oil price.

On a broader macro level, Brazier says it’s a fine line as to whether inflation or deflation represents the biggest problem for the UK economy. This comes down to what he sees as the ‘balancing act’ the government is currently undertaking as it seeks to tighten fiscal policy while keeping monetary policy loose. He believes this could lead to substantial inflation, or a rise in gilt yields if the market is not convinced the government is doing enough to reduce the deficit.

On the flipside, he anticipates lower growth as the government cuts spending, which he said could be deflationary. In fact, Threadneedle anticipates 1% GDP growth this year and 1.25% in 2011, well below forecasts from the newly formed Office of Budget Responsibility, which is tipping growth of 2.6% in 2011. 

Despite a backdrop of ‘muted growth’ and a weak consumer, Brazier is positive about the government’s indications that it is committed to cutting the deficit. He also has a positive outlook for corporate profitability in the UK.

Brazier is bullish on what he describes as ‘undervalued mega-cap stocks’ with attractive dividend yields, including BT, AstraZeneca and Unilever. He is particularly positive on BT and points to chief executive Ian Livingston’s success so far in generating cash to reduce its debt position.

Although he has steered clear of stocks with domestic UK exposure, he said house builders could look interesting, depending on what happens to interest rates.

‘If the government can bring down the deficit and keep monetary policy loose, house builders can benefit as interest rates stay low alongside mortgage rates,’ he said.

During his tenure at the helm of the Schroder UK Equity fund, Brazier posted a 6.8% loss over the three years to the end of December, while the FTSE All-Share was down 4% over the same period, according to Lipper.