Did the UK’s ‘Recession’ End in January?

Lately, our analysis of economic data has boiled down to “headlines are too skeptical” so often that we are starting to feel like broken records. So from a pure creativity standpoint, we will confess to being a tad happy that the opposite appears to be true, to an extent, of January’s UK GDP report. Monthly GDP grew 0.2% m/m, powered by services, and the universal take is that the “recession” is ending.^[i] In our view, this not only reads too much into monthly wiggles, it also overlooks some quirks affecting the growth rate. At the same time, we think the UK’s “recession” was overstated from the start, so maybe this is just more a case of sentiment catching up with reality? Either way, we think stocks are looking well beyond the news, pricing in the next 3 – 30 months as usual. But it is still worth a look.

We put “recession” in scare quotes because the Office for National Statistics (ONS) hasn’t declared one, and headlines proclaiming it hinge on the popular definition of two consecutive quarterly GDP declines. UK GDP fell -0.1% q/q in Q3 2023 and -0.3% in Q4, ergo, the “recession” moniker.^[ii] But UK GDP tends to be subject to large revisions once the second estimate gets a better handle on business investment and other inputs, so it is entirely possible this will be wiped away. Plus, most of Q4’s deterioration came from exports and government spending, which don’t really represent private sector fundamentals or domestic demand. So, chalking up the sequential declines as signs of deep-seated economic weakness seems myopic. And, lest you think this is bad for UK stocks, consider: The Bank of England and many others have been forecasting a UK recession for over a year and a half now. The surprise factor for stocks is basically nil.

At the same time, we are hard pressed to agree that January’s bounce is a sign of actual green shoots, and not just because UK monthly GDP data bounce around. Rather, to our eye, there are distortions from seasonal adjustment. One way to see this: Human Health and Social Work Activities, which rebounded from December’s -0.9% drop with a 0.6% rise.^[iii] This is a bit unexpected considering labor actions in the National Health Service (NHS) intensified in January, with more strike days resulting in canceled procedures. In the ONS surveys, businesses across the board cited it as a headwind. The agency itself said it “may have negatively impacted output.”^[iv] So the rise would suggest some seasonal distortions are at work, either from the statistical adjustment or from the holidays setting a low bar for the December comparison. Either way, while the NHS doesn’t reflect private sector activity, it pokes a bit at the headline GDP jump.

Here is another poke: The 1.9% m/m jump in retail activity, which most everyone cheered as a sign consumers are finally emerging from cost-of-living doldrums, shows some bigtime seasonal skew.^[v] This category has bounced around the past few months, rising 0.4% m/m in November, falling -1.9% in December, and now the big January.^[vi] December’s drop caught many by surprise since it is when holiday sales usually boom. But the UK imported Black Friday a few years ago, and statistical adjustment methodology still seems to be catching up to these promotions pulling more holiday demand into November. Unadjusted retail sales data show sales volumes (which strip out inflation’s impact) jumping 14.0% m/m in November and another 3.1% in December.^[vii] In prior years, the two months were closer together—like in 2022, when November grew 10.4% and December 6.9%.^[viii] And 2021, with November at 11.8% and December 4.2%.^[ix] And pandemic-distorted 2020, when they were almost even steven.^[x] Seasonal adjustments are usually based on the past few years’ trends, and this seemingly resulted in December 2023 getting pulled pretty far down. This created a favorable base for January, which is always adjusted up to smooth out the post-holiday hangover.

Understand, we aren’t trying to pooh-pooh the UK’s prospects. We have long argued the country’s economic fundamentals look better than headlines portray, and that hasn’t changed despite the optimism over January GDP. But we think it is important not to get distracted by seasonal noise and presume one month—whether it is up or down—is a trend or a landmark shift in the trend. That just isn’t a rational reading of the data, in our view.

Instead, we suggest weighing a series of readings and the likely future against sentiment. For all the GDP report optimism, sentiment toward the UK economy is actually pretty dreary. Yes, people sniff the potential for a cyclical upturn. But expectations are weak, with headlines grousing about everything from the lack of fiscal stimulus in the government’s Spring Budget to absenteeism and so-called “worklessness” among younger workers creating entrenched headwinds. Much of this discussion is sociological and misreads how fiscal policy and human capital affect growth, but it has the benefit of creating a low bar for reality to clear. Even a modest cyclical upturn will probably bring big relief at this point, and that is all stocks need.