The UK’s Mixed Q2 and Hadrian’s Wall of Worry

The results are in, and UK Q2 gross domestic product (GDP, a government-produced measure of output) grew 1.4% annualsed (0.3% q/q)—beating economists consensus expectations for a 0.0% q/q rise and outshining the general gloom we have observed over employer National Insurance hikes’ alleged economic consequences.^[i] For stocks, we think that qualifies as positive surprise. Yet under the bonnet, things were mixed, illustrating why financial commentators we follow are unlikely to cease warning of UK economic weakness. The proverbial wall of worry bull markets are often said to climb, maybe we should call it Hadrian’s wall of worry in this case, appears likely to say stay high, which we think is a plus for markets that helps facilitate future positive surprise.

When assessing GDP, we think it is important to look not just at the headline results, but what contributed to and detracted from them. Here, we saw pluses and minuses. Household spending rose 0.4% annualised (0.1% q/q), eking out continued growth.^[ii] Exports (6.7% annualised) and imports (5.7%) extended Q1’s strong growth, which we think demonstrates strong domestic and external demand.^[iii] Monthly export data still show distortions from a wave of tariff front-running through March, but exports to the US are above their levels before last November’s US presidential election, perhaps benefitting a smidge from the UK’s deal with the US later in the quarter. Even the 10% blanket tariff, it seems, didn’t bite hard.

But business investment fell -15.0% annualised, extending its very choppy trend.^[iv] We wouldn’t read a tonne into this, given its bouncy nature, but it shaved -1.6 percentage points off the headline annualised growth rate, making the private sector a net detractor.^[v] The swing factor ensuring growth was government spending and investment, which added a combined 1.9 percentage points to the annualsed growth rate.^[vi] Now, this doesn’t seem quite so bad when one considers that a lot of basic services (e.g., health care) fall into the government component, which will always cause some skew relative to more private sector-driven countries like the US. We don’t think this is a case of a bloated public sector papering over cracks. But a spade is a spade.

For stocks, we think this is all inherently neutral. Stocks aren’t GDP. They are a share in publicly traded companies’ earnings. Strong imports don’t help GDP, which uses net trade (exports minus imports) to focus on production within a country. But they do imply companies that import components or sell imported goods are humming along. We think that is a good thing for stocks even if it isn’t so good for GDP maths. Meanwhile, government investment does channel some capital to private businesses, even if it isn’t always the most efficient or effective means of doing so (always a matter of opinion, we think). If there were a long trend of the public sector booming whilst the private sector shrank, and no one noticed because GDP was still growing, we might consider it a sign of sentiment running too hot. But we don’t think that is today.

Instead, headlines throughout the publications we monitor seized on to the divide, with much of the coverage taking a pessimistic tone. Crucially, in an age where even basic economic discussion has seemingly become political, the outlets whose editorial slant might naturally align with the UK’s centre-left government expressed plenty of pessimism on this front—not just the outlets one would consider ideologically opposed. The uh-oh seemed universal.

Perversely, we think this is a good thing. It should help keep sentiment in check, preserving low expectations and keeping plenty of bricks in the bull market’s wall of worry. The UK economy doesn’t appear to us to be firing on all cylinders. But that is old news and discussed to death throughout financial news we cover, as is the general sense that it the UK economy is one sneeze away from a long hospital stay (metaphorically). For stocks, which we find move on the gap between reality and expectations, we think this preserves the potential for abundant positive surprise looking forward even if the UK economy doesn’t suddenly accelerate. When sentiment is as low as we find it presently is toward the UK economy, just ok or not as bad as feared tends to be all stocks need.

We suspect such positive surprise is likely to continue rolling in. Whilst we have seen numerous headlines about falling investment in North Sea oil production, business lending is accelerating. Its 5.2% y/y growth rate (5.4% when you expand to total business financing, including security issuance) in June is the fastest since 2019.^[vii] That was a pretty good year for the UK economy, with business investment growing and snapping a two-year slide.^[viii] If businesses weren’t keen to invest from here, we think it stands to reason they wouldn’t be securing financing. Add in resilient trade and household spending, and it to us looks like the UK private sector has more firepower than is broadly appreciated.^[ix]

This is just one reason we think UK stocks’ future looks bright. Political and fiscal policy uncertainty may weigh on investor sentiment at times, given the government is again discussing autumn tax changes. But the more this happens, the more we think society learns how to deal with it. Even if it might not look like ideal conditions, we find markets have never needed (or had) ideal. Just getting on with things is usually enough, and based on our research, the UK economy and markets have a long history of getting on.