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

The results are in, and UK Q2 GDP grew 1.4% annualized (0.3% q/q)—beating expectations for no growth and outshining the general gloom over employer tax hikes’ alleged economic consequences.^[i] For stocks, that qualifies as positive surprise. Yet under the hood, things were mixed, illustrating why fears of UK economic weakness likely aren’t going away. The wall of worry, maybe we should call it Hadrian’s wall of worry in this case, should stay high, a plus for markets that helps facilitate future positive surprise.

Whenever you assess GDP, it is important to look not just at the headline results, but what contributed to and detracted from them. Here, there were pluses and minuses. Household spending rose 0.4% annualized (0.1% q/q), eking out continued growth.^[ii] Exports (6.7% annualized) and imports (5.7%) extended Q1’s strong growth, demonstrating 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 pre-election levels, perhaps benefiting 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% annualized, extending its very choppy trend.^[iv] We wouldn’t read a ton into this, given its bouncy nature, but it shaved -1.6 percentage points off the headline annualized growth rate, making the private sector a net detractor.^[v] The swing factor ensuring headline growth was government spending and investment, which added a combined 1.9 percentage points to the annualized growth rate.^[vi] Now, this doesn’t seem quite so bad when you consider 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. It isn’t a case of a bloated public sector papering over cracks. But a spade is a spade.

For stocks, this is all inherently neutral. Stocks aren’t GDP. They are a share in publicly traded companies’ future 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. That is a good thing for stocks even if it isn’t so good for GDP math. Meanwhile, government investment does channel some capital to private businesses, even if it isn’t the most efficient or effective means of doing so. If there were a long trend of the public sector booming while the private sector shrank, and no one noticed because GDP was still growing, that might be a sign of sentiment running too hot. But we don’t think that is today.

Instead, headlines cottoned on to the divide, with a lot of handwringing. Crucially, in an age where even basic economic discussion has become political, the outlets whose editorial slant might naturally align with the UK’s center-left government expressed plenty of pessimism on this front—not just the outlets you would consider ideologically opposed. The “uh-oh” was universal.

Perversely, this is a good thing. It keeps sentiment in check, preserving low expectations and keeping plenty of bricks in the bull market’s wall of worry. The UK economy isn’t firing on all cylinders. But that is old news and discussed to death, as is the fear that it is one sneeze away from a long hospital stay (metaphorically). For stocks, which move on the gap between reality and expectations, 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 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 should continue rolling in. While there are a lot of 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. If businesses weren’t keen to invest from here, they wouldn’t be securing financing. Add in resilient trade and household spending, and it looks like the UK private sector has more firepower than appreciated.

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