Personal Wealth Management / Market Analysis
Weighing the Good and Bad in UK GDP
Whilst we don’t think March’s decline is good news, we do see some silver linings.
Has a UK recession (a decline in broad economic output) begun? That is the question financial commentators we follow globally explored Thursday when news broke that, whilst UK gross domestic product (GDP, a government-produced measure of economic output) grew in Q1 overall, it declined in March—with consumer-facing services seemingly leading the way down.[i] As the consensus viewpoint from observers we follow goes, that isn’t a good sign for a country that swallowed steep cost of living increases in April, ratcheting up the pressure on households.[ii] And we don’t totally disagree. Yet we do think investors benefit from taking a broad, measured view—of the silver linings as well as the clouds.
Now, considering we are nearly halfway through May—and given our view that stocks are forward-looking—Q1 GDP is pretty ancient history. But we think it is worth a look regardless, as it provides more clarity on the trends stocks have already incorporated into share prices, and the contrast between full-quarter and March figures seems to have hit sentiment if Thursday’s financial headlines are any indication.
With that said, after reading through the entire Q1 data release from the Office for National Statistics (ONS), we hesitate to draw sweeping conclusions for good or ill. As the release explained, Q1’s figures are subject to more uncertainty and revision than usual due to some recent methodology changes that statisticians are still ironing out.[iii] Those affected trade (particularly trade with the EU) as well as consumption.[iv] Pandemic-related skew also lingers due to the way public services—particularly the National Health Service—are accounted for in GDP.[v] Lastly, because government services aren’t sold at market prices, the adjustment applied to it for inflation (broadly rising prices across the economy) is largely imaginary.[vi] In the release, the ONS takes great pains to discourage readers from comparing results from quarter to quarter.[vii]
Even with those qualifiers, we think the data were rather mixed. GDP grew 3.0% annualised (the rate at which GDP would grow over a full year if the quarter-on-quarter growth rate repeated all four quarters), with a 2.2% annualised rise in consumer spending contributing nearly half of headline growth.[viii] That figure is inflation-adjusted, so for at least the first part of 2022, spending managed to overcome higher prices. Its contribution was also offset perfectly by a purported drop in government spending, which is partly a figment of the aforementioned inflation math—a guesstimate of an accounting entry.[ix] And, more realistically, in part the end of COVID testing and tracing and the vaccination booster drive.[x] On the investment front, we think the results were a mixed bag. Business investment fell -1.8% annualised, but that stemmed entirely from supply shortages hammering spending on transport equipment (down -32.8% annualised).[xi] Investment in tech and communication-related equipment (23.7%), intellectual property products (13.7%), dwellings (22.5%) and other structures (40.7%) was quite strong.[xii] Government investment, which the ONS noted was primarily in buildings, jumped an astounding 133.2% annualised, but we don’t think investors should make much of that.[xiii] Inventories also provided a sizable contribution after falling for most of 2021, suggesting companies finally replenished depleted stockpiles.[xiv]
Whether that turns into an inventory overhang remains to be seen, in our view, which is where we think the gloom over March GDP comes in. Output fell a mere -0.1% m/m, and the series overall is rather volatile, with frequent one-off drops.[xv] But many commentators we follow portrayed the details as discouraging in light of the cost of living crisis. Retail trade dropped -2.8% m/m, and that was before April’s headwinds set in.[xvi] Most observers we follow warn spending on goods will deteriorate further as the higher household energy price cap and recent stealth tax hikes kick in. We think that is fair enough, but as the ONS noted, the global automobile shortage contributed a bunch to the drop—that is a supply problem, not necessarily a demand problem, in our view.[xvii] Outside that category, consumer-facing services did relatively well: The nebulously named Other Personal Services, which was the largest positive contributor to consumer services, rose 4.0%.[xviii] Meanwhile, another big detractor was property rentals, which are a pretty widely reported political sore spot given the ongoing tussle over buy-to-let.[xix]
None of this is to dismiss the pain from high petrol, food and household energy costs. But even here, we think there are perhaps some reasons for optimism. For one, global oil and natural gas prices have cooled recently.[xx] One thing the UK has going for it is that it produces much of its own energy, making its energy prices less sensitive to currency swings than, say, Japan (energy commodities are priced in dollars, so when an energy importer’s currency is weak, oil and gas priced in dollars are even more expensive when converted to local currency).[xxi] Also helpful, mining and quarrying activity—which includes North Sea oil and gas production—jumped 2.8% m/m.[xxii] Production of coke and refined petroleum products, which is the manufacturing subset that includes petrol refining, soared 5.7% m/m, on the heels of February’s 3.9% and January’s 2.3%.[xxiii] It may take time to show up in fuel prices, but the industry is responding to consumers’ acute pain and needs—both in the UK and globally.[xxiv] Mind you, we think high petrol prices create winners and losers rather than hurt spending and GDP, as spending on fuel is still consumer spending—and the UK economy is overall quite energy-efficient, which we think helps limit high energy costs’ overall impact.[xxv] But we also know the pain on many households is severe on this and several other fronts, so any relief would be welcome. We think it may come sooner than many think.
As for stocks, we think they look forward—not backward. The UK’s headwinds aren’t small, but we think they are also very well known. Energy costs have been top of mind for over half a year now, since a shortage of wind power sent natural gas prices soaring and put several energy suppliers out of business, tied to price controls’ limiting their ability to pass increased costs on.[xxvi] Those same price controls mean that April’s increase was also pencilled in months ago—just as the Bank of England recently pencilled in another increase for this coming October.[xxvii] Again, whilst we don’t think this is objectively good, in our experience, stocks don’t deal in terms of good and bad. In our view, they weigh whether economic reality is likely to be better or worse than the consensus anticipates over the next 3 – 30 months.
And on that front, well, forecasts are low. We think recession chatter from commentators we follow, swirling for weeks now, plays into that. So does the drumbeat of reporting and political wrangling over the cost of living crisis, in our view. More recently, commentators’ warnings about a potential trade war with the EU if Foreign Secretary Liz Truss unilaterally discards the Northern Ireland Protocol have prompted a fresh wave of dismal forecasts. And we think stocks have noticed. Though the MSCI UK IMI Index is outperforming global markets year to date, it has trailed during this downturn’s April – May downdraft.[xxviii] The why behind volatility is always harder to know than the what, in our view, but we can see a strong argument that stocks have priced in commentators’ warnings about the UK economy in a hurry, at least to some notable extent.
As our historical analysis shows, at any time, even in a global expansion, there will always be pockets of economic weakness as well as strength. Perhaps the UK is a weak pocket this year. Perhaps that will translate to a recession, using the popular definition of two consecutive GDP contractions. But we think there is also precedent for a growing world to pull weaker countries along. The UK itself is evidence of this. A decade ago, which happens to be the last time inflation topped 5% in Britain (due primarily to an increase in the value added tax), data initially showed the UK endured a double-dip recession in 2012.[xxix] It wasn’t an easy time for many. But UK stocks soldiered through, as did UK households.[xxx] The economic downturn was short, and eventually data revisions wiped the recession from the history books, with 5.0% annualised growth in Q3 2012 separating contractions that Q2 and Q4.[xxxi] Growth returned in earnest in 2013, kicking off a multiyear positive run—and UK stocks participated in the rest of that decade’s global bull market (a long period of generally rising equity prices).[xxxii]
In our experience, bad news that hits the wires when stocks are slumping can hit sentiment disproportionately. But we think it is important for long-term growth investors to keep a cool head, put data in context and resist the temptation to extrapolate bad results either forward or globally.
[i] “GDP First Quarterly Estimate, UK: January to March 2022,” Office for National Statistics, 12/5/2022, and “GDP Monthly Estimates, UK: March 2022,” Office for National Statistics, 12/5/2022.
[ii] “Rising Cost of Living Puts Brakes on Spending,” British Retail Consortium, 10/5/2022.
[iii] “Measuring Monthly and Quarterly UK Gross Domestic Product During the Coronavirus (COVID-19) Pandemic,” Office for National Statistics, 25/8/2020.
[iv] “Understanding the Latest Changes to UK Trade Figures with the EU,” Office for National Statistics, 11/3/2022.
[v] “Measuring Monthly and Quarterly UK Gross Domestic Product During the Coronavirus (COVID-19) Pandemic,” Office for National Statistics, 25/8/2020.
[vi] “GDP First Quarterly Estimate, UK: January to March 2022,” Office for National Statistics, 12/5/2022.
[viii] Source: FactSet, as of 12/5/2022.
[ix] Source: FactSet, as of 12/5/2022.
[x] “GDP First Quarterly Estimate, UK: January to March 2022,” Office for National Statistics, 12/5/2022.
[xi] Source: FactSet, as of 12/5/2022.
[xiv] “GDP First Quarterly Estimate, UK: January to March 2022,” Office for National Statistics, as of 13/5/2022.
[xv] Source: FactSet, as of 12/5/2022.
[xvi] “GDP Monthly Estimates, UK: March 2022,” Office for National Statistics, as of 13/5/2022.
[xx] Source: FactSet, as of 13/5/2022. Statement based on Brent Crude Oil spot price and Dutch TTF gas price.
[xxi] “UK Energy in Brief 2021,” Department for Business, Energy & Industrial Strategy, 29/7/2021.
[xxii] Source: FactSet, as of 12/5/2022.
[xxiv] “Short-Term Energy Outlook,” U.S. Energy Information Administration, May 2022.
[xxv] Source: International Energy Agency, as of 20/10/2021.
[xxvi] “Global Energy Crisis: How Key Countries Are Responding,” Jennifer Rankin, Oliver Milman and Vincent Ni, The Guardian, 12/10/2021, and “Energy Price Rise Includes £68 for Failed Firms, Says Ofgem,” Simon Read, BBC News, 4/2/2022.
[xxvii] “Monetary Policy Report – May 2022,” Bank of England, 5/5/2022.
[xxviii] Source: FactSet, as of 13/5/2022. Statement based on MSCI UK IMI Index total returns and MSCI World Index with net returns in GBP, 31/12/2021 – 12/5/2022 and 8/4/2022 – 12/5/2022.
[xxix] Source: Office for National Statistics, as of 13/5/2022.
[xxx] Source: FactSet, as of 13/5/2022. Statement based on MSCI UK IMI Index total return in GBP.
[xxxi] Source: FactSet, as of 12/5/2022.
[xxxii] Ibid. Statement based on UK GDP, MSCI UK IMI Index total return and MSCI World Index return with net dividends in GBP.
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