Recession or No, Stocks Are OK With the UK

UK gross domestic product (GDP, a government-produced measure of economic output) grew 0.6% q/q in Q1, the fastest growth since Q4 2021’s reopening-driven pop and, according to many financial headlines we saw, marked an exit from recession.^[i] Yet this seeming milestone didn’t yield universal cheer—rather, many commentators we follow argued the UK’s economic prospects remain poor. In our view, last quarter won’t tell you anything about what lies ahead. However, these figures still have value for investors: In our view, they confirm the better-than-appreciated reality stocks long ago pre-priced—a lesson in how markets work.

Q1 growth was fairly broad-based, albeit not universal. Services (0.7% q/q) led the way, with 11 of 14 subsectors expanding.^[ii] Heavy industry (0.8% q/q) rose, with manufacturing—the largest subsector—up 1.4%.^[iii] However, construction slipped -0.9% q/q, as historically wet February weather (when output slipped -2.0% m/m) hampered work.^[iv]

In expenditure terms, household spending ticked up 0.2% q/q after two straight declines.^[v] Moreover, when excluding net tourism, domestic consumption was even stronger (0.6% q/q).^[vi] Gross capital formation rose 1.4% q/q, with business investment climbing 0.9%, though trade was weak: Both exports (-1.0% q/q) and imports (-2.3%) contracted, extending weakness.^[vii]

Overall, Q1 was solid for UK GDP, which led the Group of Seven.^[viii] Also notable: GDP per capita (or per head), a measure of economic output that factors out population growth, rose 0.4% q/q, growing for the first time since Q1 2022—countering a concern raised by the International Monetary Fund (IMF), which cited per-capita GDP as reason to be down on Britain’s economy.^[ix]

The most common reaction we read in reaction to Q1 GDP: The UK’s recession is over (huzzah). But this assumes the UK was in recession—which we think is debatable.

According to the popular technical recession threshold of two consecutive quarterly GDP contractions, yes, the UK was in recession. But this categorisation is oversimplified, in our view. As the Office for National Statistics (ONS) notes, a technical recession doesn’t account for a downturn’s scale (e.g., breadth, depth or length) or the broader context (e.g., the economic environment at the time).^[x] Note, too, the possibility of revisions. Back in 2011 – 2012, initial data showed a double-dip UK recession (i.e., when GDP contracts again after a brief period of expansion).^[xi] A year later, the ONS revised the numbers, which showed a continued expansion instead.^[xii] But whatever you think of this, if last year’s contraction were a recession, it would be the shallowest since 1990 – 1992’s recession.^[xiii] Back then, UK GDP contracted -2.9% from peak to trough—around seven times as deep as last year’s two-quarter -0.4% contraction.^[xiv]

We also don’t think stocks have missed anything with the UK economy. Rather, they moved first, which our research finds is the norm. To see this, go back to 2022, when UK stocks struggled alongside global stocks—and the latter entered a bear market when measured in US dollars.^[xv] UK stocks outperformed thanks to their high Energy weight, but they still hit tough sledding.^[xvi] According to our research, a host of fears, including inflation, monetary policy institution rate hikes and, yes, recession forecasts (particularly in the UK and Europe) roiled sentiment. We don’t think UK stocks ignored that recession speculation. Rather, they pre-priced the likelihood of a downturn, which may have contributed to UK stocks’ -11.4% downturn (in pounds) from mid-April through mid-October.^[xvii]

Interestingly, we saw more dour economic forecasts emerge after UK stocks’ October 2022 bottom. The Bank of England predicted the longest UK recession on record in November 2022.^[xviii] At the start of 2023, we observed some experts forecasting a UK downturn on par with Russia’s—even though the latter was waging a war and facing Western sanctions.^[xix] At that point, though, we think recession worries were old news. Perhaps they affected sentiment and contributed to UK stocks’ volatility and underperformance in 2023, but Energy’s troubles had a lot to do with that as well.^[xx] At any rate, with UK stocks on a tear since late October 2023—well before the ONS reported the Q3 2023 contraction—it seems fair to say stocks had already moved on.^[xxi]

In our view, there is still room for reality to beat expectations from here. Despite a solid Q1, scepticism laces most economic analyses we read. Some commentators we follow noted the UK’s trend lags other major developed nations and that GDP has just returned to prepandemic levels (and even then, just barely). We have seen several economists argue productivity is still weak and that UK households have seen little improvement to their living standards. Other experts have noted growth isn’t equal across all industries (e.g., food services continue to struggle more than other services). To us, all this caveating implies expectations remain subdued—and there is likely room for reality to continue to surprise to the upside.

Take business investment, which is often GDP’s swing factor according to our studies of economic history. When times are tough, we have observed that companies get lean and mean to better weather anticipated challenges. Hence, business investment tends to lead the way down and fall more than GDP. It then recovers when companies stop focussing on doing more with less and start seeing long-term projects as worth the risk—pumping a broader recovery. Last year, business investment fell ever so slightly in Q2 (rounding to 0% q/q but -0.1% annualised) and fell -2.8% q/q the following quarter.^[xxii] So it turned down before GDP did. But it jumped 1.4% q/q in Q4—a sign businesses had started moving on and were ready to go on offense (even though headline GDP contracted).^[xxiii] We think this trend is likely to continue this year.

Moreover, if major trouble lurked for the UK economy, we think stocks, as leading economic indicators, would signal it first. Yet UK stocks have been in line with global stocks for the year and rose through April’s global pullback.^[xxiv] We aren’t saying the UK economy will speed up from here. Middling growth may continue. But in our view, the widespread focus on soft spots of the economy and scepticism about future prospects suggest the wall of worry remains high for UK stocks.