UK GDP and a Lesson on How Markets Work

One of the central tenets of our investment philosophy, which we have mentioned here often^[i], is that we think stock markets are forward-looking, discounting expected events over the next several months. Economic data, by contrast, are backward-looking. Data released now reflect activity that happened in a previous month, quarter or year. Therefore, if you are looking at economic data for clues into what stock markets will do, we think you are probably mistaken, as prices likely already reflect that earlier economic activity—and have for some time. To see this clearly, here is a shining, timely example: February’s UK GDP, released Tuesday.

Most countries release GDP quarterly, but the UK—like Canada—produces a monthly report, giving more insight into the economy’s short-term twists and turns. That has been particularly illuminating during the pandemic, as it gives a more detailed look at the lockdowns’ varying economic impacts. The third UK lockdown took effect in early January, and that month’s GDP fell -2.2% from December.^[ii] But in February, there was a slight recovery. GDP grew 0.4% m/m, even as strict nationwide business restrictions remained.^[iii] To us, that is a noteworthy sign of the country’s economic resilience, which we think probably benefits many people at a personal level.

But to stocks, it is very old news. That would be true of any month’s GDP, but something that happened the day before the release ties a bow on it: Businesses began reopening from that third lockdown. That reopening has been scheduled since February 22 , when Prime Minister Boris Johnson announced it. Also widely known: The government’s plans to have all remaining restrictions lifted by June 21, provided the virus doesn’t escalate again. For nearly two months, the government’s reopening timetable has been common knowledge—a fact investors were likely well aware of as they bought or sold. This is what we refer to when we say markets anticipate expected events.

So, put yourself in a British investor’s shoes today. What is a bigger factor as you decide whether to own stocks: the knowledge that UK GDP rose a bit in February, or the knowledge that economic activity could very well be back to normal in a little more than two months? Which of those items is likelier to have more influence over corporate profits and shareholder returns over the next year? If you picked the forward-looking option, we think you are headed in the correct direction. The future—generally much further than the next two months—is where investors generally look; therefore, we think it is where markets generally look.

We like economic reports (obviously—we write about them a lot).^[iv] They are interesting and help us identify long-term trends, which can then help us put expectations in context. So in our opinion, they are useful. But on their own, we don’t think they are a solid basis for making investment decisions. They are just a backward-looking confirmation of events that investors have already lived through and, in our view, showed up in stock prices long ago.