Much Ado About UK GDP

Midway through November, a month and a half after September’s end, Q3 economic data are rather backward looking. Yet the UK’s Q3 GDP (gross domestic product, a government-produced measure of economic output), released late last week, let commentators we follow make comparisons, and the verdict amongst some seems to be that Britain is falling behind.^[i] You see, on a quarterly basis, UK GDP remains -2.1% below its Q4 2019 pre-pandemic peak, lagging other major developed world economies.^[ii] Fair enough, to an extent. For markets though, we think this is trivia. Whilst we think economic growth supports stocks, it isn’t a race, and our research shows stocks don’t move in lockstep with GDP.

Most coverage we read pointed to the UK’s slowing growth, which decelerated to 1.3% q/q in Q3 from Q2’s 5.5%, saying this means Britain’s recovery is faltering under the weight of post-Brexit supply disruptions and labour shortages.^[iii] Whilst those issues may be crimping growth on the margin, they aren’t unique to the UK, in our view. We don’t think Brexit is the primary, or even a major, cause. For example, exports fell -1.9% q/q led by a -5.8% drop in goods exports.^[iv] But the quarterly decline was driven by non-EU exports.^[v] Meanwhile, services exports rose, driven by financial services.^[vi] Imports rose 2.5% q/q, mostly from non-EU fuel imports.^[vii] Not everything is about Brexit. Also notable: Services imports rose, too, as easing travel restrictions allowed more Britons to vacation abroad.^[viii]

Beyond trade, manufacturing and construction fell -0.3% q/q and -1.5%, respectively, due mainly to ongoing chip shortages for cars and building supply delivery delays.^[ix] But services, by far the UK’s biggest economic driver at close to 80% of GDP, rose 1.6% q/q, with accommodation and food services jumping 30.0% and recreation services up 19.6% in Q3.^[x] Services output overall still slowed from Q2’s 6.5% q/q growth, but it is now just -0.7% below its Q4 2019 level.^[xi] In our view, growth was always likely to slow as output approached pre-pandemic highs and the burst from easing restrictions faded.

We think this is pretty much the same story as the rest of the developed world: Outside of lingering supply chain wrinkles as the world restarts, economic activity—and growth rates—are returning to normal after the temporary reopening boom. The UK’s monthly GDP data show this more clearly, in our view. (Exhibit 1) September growth accelerated to 0.6% m/m, following a flattish July and August, leaving monthly GDP -0.6% below its February 2020 pre-pandemic level.^[xii] The rebound in activity coincides with reopening milestones and the end of the so-called pingdemic, in which COVID contact alerts sidelined countless workers for weeks.^[xiii] It seems to us the more restrictions have eased, the more activity has returned closer to pre-pandemic norms. The latest blip higher stemmed from the resumption of face-to-face doctor appointments, allowing human health activities to rise 6.4% m/m.^[xiv]

Exhibit 1: Monthly UK GDP Almost Back to Level, But Still Some Work Left

Source: ONS, as of 11/11/2021. Monthly UK GDP and consumer-facing services, February 2020 – September 2021. Consumer-facing services consists of retail trade, food and beverage serving activities, travel and transport, and entertainment and recreation.

Whilst overall services in the UK has unsurprisingly tracked GDP closely, the subset of consumer-facing services continues to lag, remaining -5.5% below February 2020’s level.^[xv] As the Office for National Statistics (ONS) noted, the main culprit for September’s -0.6% m/m dip in these categories was a -13.3% decline in car sales, which stemmed from lack of supply.^[xvi] But as the ONS also pointed out, travel and entertainment categories are starting to pick up strongly.^[xvii] Although they remain historically depressed, as restrictions lift, we think they are following a familiar script: big gains as pent-up demand releases, which subsequently subsides. In our view, this hasn’t been a smooth process, occurring in fits and starts at different times in different sectors. More COVID waves this winter could spur further wobbles, and supply chain issues may persist. To us, though, the UK economy has shown over the last year it can handle them, which markets appear well aware of, mitigating any impact on stocks.

Looking forward, we think there is likely some more catch-up growth ahead, particularly as supply bottlenecks resolve. But the potential for new kinks aside, markets have mostly moved on, in our view. Meanwhile, many commentators we follow seem to be overlooking recent positives. UK steelmakers and fertiliser plants have quietly started production again.^[xviii] This is as the energy crunch subsided with wind power generation recovering.^[xix] Port operators are also rerouting traffic and clearing logjams, which doesn’t get as much attention as when there is major disruption, but it undercuts perceptions trade is frozen.^[xx] Trade volumes are surging even as freight rates hit record levels—we think there is ample incentive (profits) to move inventory.^[xxi]

Many commentators we follow, though, still seem to be searching for a second shoe to drop.^[xxii] They warn inflation, Bank of England rate hikes or Brexit (finally) will bite.^[xxiii] We aren’t so sure. Not only are these items unlikely to derail the economy, according to our research, but they are well-known issues markets have seemingly mulled over for months—and apparently found wanting, judging from UK stocks’ continued ascent.^[xxiv] Based on our analysis, if these items don’t spark a downturn, the result would probably be a better-than-expected outcome for stocks to enjoy. This doesn’t mean UK stocks are likely to lead the world, according to our research—the UK’s sector composition likely presents a headwind—but they are still likely to participate in this global bull market.