UK GDP and a Lesson on How Markets Work

One of the central tenets of our investment philosophy, which we have mentioned here often, is that we think equity markets are forward-looking—they discount expected events over the next several months. Economic data, by contrast, are backward-looking. Data released now reflect activity that happened in a previous month, quarter or year. Therefore, if you are looking at economic data for clues into what equity markets will do, we think you are probably mistaken, as share prices will likely already reflect that earlier economic activity. This may seem like a rather abstract concept, so let us look briefly at a shining, timely example: February’s UK gross domestic product (GDP), released Tuesday.

GDP is a government-produced estimate of national economic output. Most countries release it quarterly, but the UK—like Canada—produces a monthly report, giving more insight into the economy’s short-term twists and turns. That has been particularly illuminating during the pandemic, as it gives a more detailed look at how the past year’s lockdowns have had varying economic impacts. England’s third lockdown took effect in early January, and that month’s GDP fell -2.2% from December.^[i] But in February, there was a slight recovery. GDP grew 0.4% m/m, even as the entire country remained under lockdown.^[ii] To us, that is a noteworthy sign of the country’s economic resilience, which we think probably benefits many people at a personal level.

But does it really mean much to shares now? Consider what happened the day before the Office for National Statistics released this report: Businesses began reopening from that third lockdown. That reopening has been scheduled since 22 February, when PM Boris Johnson announced it. Also widely known: The government’s plans to have all remaining restrictions lifted by 21 June, provided the virus doesn’t escalate again. For nearly two months, the government’s reopening timetable has been common knowledge—a fact investors were likely well aware of as they bought or sold shares. This is what we refer to when we say markets price expected events.

So, put yourself in an investor’s shoes today. What is a bigger factor as you decide whether to own equities: the knowledge that GDP rose a bit in February, or the knowledge that economic activity could very well be back to normal in a little more than two months? Which of those items is likelier to have more influence over corporate profits and shareholder returns over the next year? If you picked the forward-looking option, we think you are headed in the correct direction. The future is where investors generally look; therefore, we think it is where markets generally look—although we think equities are pricing much further out than the next two months.

We like economic reports. They are interesting and help us identify long-term trends, which can then help us put expectations in context. So in our opinion, they are useful. But we don’t think they are a solid basis for making investment decisions. They are just a backward-looking confirmation of events that investors have already lived through and, in our view, were reflected in share prices long ago.