Silver Linings in UK GDP

As global markets suffered another bad day Monday, investors had more dreary news to chew over.^[i] One bit came from the UK, where the Office for National Statistics (ONS) reported monthly gross domestic product (GDP, a government-produced measure of economic output) fell -0.3% m/m in April, the second-straight drop—setting off another round of recession warnings from commentators we follow.^[ii] In our view, the jury is still out on the UK economy and whether this year’s painful cost-of-living increases will be enough to tip consumer spending—and overall output—negative for a sustained period. But under the bonnet, we think the seemingly weak GDP report featured some reasons for optimism.

As most of the coverage we encountered pointed out, all three of the major monthly GDP components—services, heavy industry and construction—fell. Industrial output fell -0.6% m/m, with manufacturing (-1.0%) leading the way down, whilst construction activity fell -0.4%.^[iii] Services—about 80% of total UK output—fell -0.3% m/m, but this comes with a big asterisk: the end of COVID testing and tracing and the waning vaccination programme.^[iv] COVID-related activity has skewed GDP wildly at times over the past two years, as it shows up as big jumps and dives in the human health and social work activities component of services industry output—an economic accounting quirk that appears to be largely unique to the UK. This category fell -5.6% m/m in April, shaving half a percentage point off the service sector’s growth rate.^[v] Exclude it, and services would have grown 0.2% m/m, which would be enough of a move to make headline GDP growth flattish or slightly positive.^[vi] Now, flattish growth isn’t great, but it also isn’t a deepening contraction, and the latter is what many commentators we follow warn of now.

Elsewhere in the services sector, we see some bright spots—especially in consumer-facing areas that, in theory, should be benefitting from the easing of COVID restrictions and return of travel and leisure activities. Overall, the ONS estimates consumer-facing services rose 2.6% m/m.^[vii] Wholesale and retail trade jumped 2.7% m/m—and that figure is adjusted for inflation—whilst activity at restaurants and hotels rose 1.0%.^[viii] The nebulously named “other service activities,” which includes the beauty industry, soared 5.5% m/m.^[ix] Interestingly, retail’s rapid rise came despite the tax hikes and energy price cap increase that took effect in April, suggesting that—at least at the outset—consumers were far more resilient to these added pressures than many economists we follow deemed likely. Also positive, in our view: Auto sales contributed strongly to the retail total as supply recovered, seemingly confirming our hunch that March’s slide wasn’t a product of weak demand.

On the manufacturing side, things were more uniformly negative—which we point out not to panic anyone, but rather in the interests of being complete and objective. Amongst the 13 manufacturing sub-sectors, 8 contracted, 2 were flat and 3 rose.^[x] Perhaps the most frustrating bit on this front is that the sub-sector including oil refining fell -3.6% m/m, which isn’t ideal amidst today’s high petrol prices.^[xi] Yet oil and gas extraction (a component of the mining sub-sector) rose for the fifth straight month, bringing April’s output 4.8% higher than December’s—a sign the North Sea oil industry is responding to high prices and fears of a global shortage.^[xii] It may take time for this to flow through to higher petrol and diesel refining, but it does appear the market is working as we find it typically does when prices jump on supply concerns. Typically, high prices encourage production, which helps ease shortages and stabilise prices. It doesn’t happen overnight, but the process does appear to be underway, and we think it is likely to help bring some relief eventually. We don’t think this is necessary from an economic standpoint, as April’s data suggest to us that UK consumers can overcome the pain of higher fuel costs, but we imagine everyone will welcome it all the same.

So, in short, we don’t think these latest data are reason to radically downshift projections for Britain’s economy. When we look at the report, we see pockets of strength and weakness that mostly balance each other out. In our experience, no economy grows uniformly or in a straight line—most every GDP report we encounter strikes us as an amalgam of good and bad. In our view, stocks know this. They have also been dealing with grim UK economic forecasts for months now, and unless markets are totally inefficient, we think it stands to reason a lot of that expected weakness is already incorporated into stock prices.

In our view, stocks look about 3 – 30 months ahead, with surprise a large swing factor. Therefore, we don’t think stocks need perfection—just a reality that goes modestly better than commentators, economists and the investing world at large thinks is likely. We suspect a UK economy that plods along would be a nice surprise in a world where most seem to think terrible results are inevitable.