Britain’s Flattish Growth Is Still Better Than Last Year’s Forecasts

Here is a question we have been mulling since UK May monthly GDP (gross domestic product, a government-produced measure of economic output) came out Thursday morning: When is more information not necessarily helpful for investors? When the Office for National Statistics (ONS) announced it would start publishing a monthly GDP series five years ago, we were keen. We thought a more timely look at broad output would add more detail and insight into developing trends. Over the last year, however, we have started wondering if the added frequency merely shines a spotlight on monthly variability, obscuring long-term trends. In our view, May’s results are a case in point: GDP fell -0.1% m/m, partly reversing April’s 0.2% growth and bringing the rolling 3-month tally to 0.1%.^[i] But ONS’s data release explained the drop stemmed primarily from one-off events, including the extra bank holiday for King Charles’s coronation and an uptick in industrial action, which disrupted several industries.^[ii] Rather than get hung up on the latest wiggles, we suggest zooming out, viewing the broader trend and comparing that with expectations—the way we have found stocks do.

Exhibit 1 shows monthly GDP since mid-2018, giving a look at the present and how it compares with pre-pandemic trends. As you will see, monthly output has been more or less flat for the past year. But it was also pretty flat in the half-year leading up to COVID lockdowns, so we think it seems hard to argue the present malaise is new or surprising to stocks.

Exhibit 1: UK Monthly GDP’s Long Sideways Crawl

Source: ONS, as of 13/7/2023.

Crucially, our research suggests stocks care less about absolute economic results than they do how those results square with expectations (in conjunction with political developments affecting commerce). And based on our read of financial commentary and forecasts, expectations for the UK economy have been rather dreary. Over the last year, most publications we follow have projected recession as mounting cost-of-living pressures hit households hard. The Bank of England, whose forecasts likely receive most attention, projected last August that the UK would enter recession that autumn: “Output is projected to fall in each quarter from 2022 Q4 to 2023 Q4. Growth thereafter is very weak by historical standards.”^[iii] (Around the same time, the Office for Budget Responsibility forecasted a downturn on par with the 1930s, which is quite significant, in our view.)

Q2 results won’t be out for a few more weeks, but GDP grew 0.1% q/q in Q4 2022 and again in Q1 2023.^[iv] May’s monthly output was 0.7% higher than September 2022’s.^[v] We don’t find these results rousing, and that September comparison is flattered by the added bank holidays for the late Queen’s death and funeral, which the ONS reported hit output that month. But in our view, an economy that is eking out slight growth is an economy that isn’t in recession, pretty easily defying all those dour forecasts.

Note, too, that these better-than-expected results occurred despite the BoE hiking more than it factored into its projections. The BoE’s baseline forecast last August presumed “the path of Bank Rate implied by financial markets, which rises to 3.0% in 2023 Q2.”^[vi] Yet the BoE has now lifted the Bank Rate to 5.0%.^[vii] So despite policy being tighter than the BoE’s economists anticipated, growth beat forecasts. For those keeping score: Reality 2, monetary policy institution forecasts nil.

Now, whilst a flat monthly GDP trend skewed by a bunch of strikes and one-off holidays is decidedly better than rock-bottom expectations, we think it is fair to say UK stocks don’t exactly reflect this. In price terms, the MSCI UK Investible Market Index crossed below -10% from its mid-February high in early July, officially hitting correction territory.^[viii] It has since rebounded a bit, but turning points are clear only in hindsight, and more short-term volatility is always possible.^[ix] We see a couple of likely culprits for this, and we think both should clear soon. One is the fall in copper prices, which hit the UK’s large Metals & Mining industry.^[x] We have found stocks tend to price in such moves quickly, and we don’t think it is likely to be a lasting headwind.

In our view, the other is general sentiment, which seems hung up on widespread warnings of a mortgage crisis. Mortgages that are about to exit their fixed-rate periods face the prospect of their payments jumping from the generational-low interest rates of two and five years ago to a roughly 7.0% average rate.^[xi] That amounts to a couple hundred pounds per month for most households, spurring commentators we follow to express concerns about higher living costs further whacking consumer spending—and therefore economic growth.^[xii] We don’t dismiss the headwinds, but mortgage rates were in this neighborhood for most of the 1990s and 2000s, and consumer spending grew just fine.^[xiii] Plus, accelerating wage growth, which topped 7.0% in the three months through May, has likely helped buffer higher living costs.^[xiv] Yes, frozen income tax bands are eating some of this, but falling household energy costs can help counterbalance it as Ofgem’s energy price ceiling falls.^[xv] Also, and we aren’t saying this is a perfect measure, the household savings ratio remains well above prepandemic trends at 8.7% in Q1 2023, the latest data available.^[xvi]

So whilst higher home payments might be a hardship for some households, we think it is a stretch to say they will force the entire country to make big discretionary spending cuts. As this perceived negative gradually proves false like the BoE’s recession forecasts did earlier, stocks should move on, in our view—pulled higher by positive global forces.