A Springtime Thaw?

Did winter showers start bringing some springtime flowers for the UK economy? (Photo by aleroy4/iStock by Getty Images.)

What is this about a wedding we hear? Possibly boosted by preparations for the Duke and Duchess of Sussex’s nuptials, UK April retail sales snapped back after the dreary winter, helping improve economic cheer. Adding to the good news, inflation fell to its lowest rate in 13 months in April. Both figures are backward-looking and not predictive for shares, but we think better than expected results—and lots of flowers—might help ease some of the recent economic uncertainty, perhaps helping lift investors’ spirits.

In our daily readings of UK media the past few months, middling economic data and equity market volatility have seemingly caused investor sentiment toward Britain to darken. Q1 GDP probably didn’t help as growth slowed to its weakest since 2012. Even though the “Beast from the East” bore much of the initial blame, many investors worried there was more at work than weather. IHS Markit/CIPS’ Purchasing managers’ indexes (PMIs) for April—surveys estimating the share of firms experiencing growth in services, manufacturing and construction—showed more than half of firms grew. The surveys’ subindex of new orders—a look at future production—suggested further expansion ahead. That said, the PMI readings weren’t as strong as analysts expected. Manufacturing PMI slowed, whilst services sped only modestly.^[i]

This brings us to last week’s retail sales report, which showed shoppers buying 1.6% more by volume (quantity purchased) in April than March, “smashing expectations” and reversing March’s -1.1% m/m decline.^[ii] By value (amount spent), April retail sales also rose 1.6% m/m, rebounding from -0.9% in March.^[iii] Moreover, sales growth was broad based, with all sectors save department stores rising. Even there, as the Office for National Statistics (ONS) noted, “Department stores declined following relatively strong sales last month, when their online sales were boosted during the adverse weather.” Some media coverage noted the 4.7% rise in automotive fuel sales, worrying high gas prices would dent sales elsewhere—but excluding gasoline, retail sales still rose 1.3%, countering that narrative.^[iv] Now, we wouldn’t get too excited over one month’s data. Plus, retail sales are just a small slice of UK households’ consumer spending—services comprise the bulk. But it does help argue against the thesis that growth is peaking and the UK economy flailing. Growth rates might cool a bit once the frenzy for Royal Wedding tchotchkes fades from the data and recreational bakers have had their fun working with elderflower cordial, but with Bank of England data showing credit markets looking healthy and incomes on the rise, we see no reason demand should falter materially.

Exhibit 1: UK Retail Sales Spiky but Up

Source: Office for National Statistics, as of 24/5/2018. Sales volumes for all retailing including automotive fuel, seasonally adjusted, January 2014 – April 2018.

We believe real (inflation-adjusted) incomes should get a further boost from slowing inflation. When the consumer price index’s (CPI) annual inflation rate crossed above 3% late last year, many media observers warned it would reduce households’ purchasing power, endangering the economic upturn. But after peaking last November at 3.1%, inflation has slowed.^[v] April’s CPI rose 2.4% y/y, its slowest increase since March 2017.^[vi] Some may breathe a sigh of relief—and take a vacation as lower airfares led the decline^[vii]—but even when inflation was higher it didn’t stop consumer spending or broader economic growth. Whilst rising inflation was never very threatening to the UK’s economic expansion or bull market, in our view, it seemingly did impact sentiment. Now that it is fading a bit, we think investors should be able to focus more on the UK’s positive fundamentals.

Exhibit 2: Inflation Is Calming

Source: Office for National Statistics, as of 24/5/2018. Consumer Price Index All Items and “Core” CPI excluding Energy, Food, Alcohol & Tobacco, January 2014 – April 2018.

On Friday, the ONS released its second estimate of Q1 GDP, confirming its earlier estimate of 0.1% q/q (0.4% annualised) growth. The ONS talked down the weather’s impact, noting the rise in energy production offset some weather-related declines in construction and shopping—but under the hood there were some bright spots. Consumer spending rose 0.2% q/q (1.0% annualised), slowing only slightly from Q4 2017.^[viii] Business investment slipped -0.2% q/q, but the declines were concentrated in transport equipment (-3.7% q/q)—long a volatile category—and structures (-0.6% q/q).^[ix] Investment in heavy machinery and plant equipment jumped 3.0% q/q, and intangible fixed assets—including software and research & development—rose 1.4% q/q, its fourth straight positive quarter.^[x] Overall, we don’t see evidence businesses are universally retrenching.

Looking ahead, we see reasons for optimism. The yield curve remains positively sloped, supporting bank lending and money supply growth, which keeps capital flowing to households and businesses—another sign reality is better than many media portrayals suggest. The UK economy may not lead the developed world, but as it hums along, we expect continued growth should reveal a resilient reality, perhaps buoying sentiment long after wedding joy fades from the headlines.

[i] Source: IHS Markit, as of 25/5/2018.

[ii] Source: Office for National Statistics, as of 25/5/2018.

[iii] Ibid.

[iv] Ibid.

[v] Ibid.

[vi] Ibid

[vii] Though mostly a seasonal quirk from Easter—when airlines raise prices—falling earlier in April than last year.

[viii] Ibid.

[ix] Ibid.

[x] Ibid