Inside Britain’s ‘Gangbusters’ Q2

Is UK GDP growing “gangbusters” … or stalling out? The answer probably depends on which coverage you read. Some outlets cheered Q2’s 0.6% q/q (2.3% annualized) growth and labeled it the former, repeating an adjective a beleaguered staffer at the Office for National Statistics (ONS) got scolded for using in Q1 after politicians touted it.^[i] Others zeroed in on monthly GDP, warning June’s flat read is a sign momentum is fading and high rates are choking the economy. Seems to us like a good snapshot of Britain’s mixed sentiment: Perhaps too much cheer in some corners and not enough in others. This suggests to us UK stocks still have some wall of worry to climb.

Q2’s report had some nice nuggets, but we don’t think it is quite as smashing as sunnier coverage suggests. Consumer spending slowed from 1.7% annualized in Q1 to 0.8%, which is a decent growth rate but hardly red-hot.^[ii] Most of the eye-popping 11.5% annualized jump in national expenditure came from His Majesty’s government, whose spending soared 5.9% annualized, adding 1.2 percentage points to headline growth.^[iii] Ye olde government was also the major investor in Q2: Business investment fell -0.4% annualized, while government investment surged 11.0%.^[iv] Imports’ 34.8% annualized growth is encouraging, as imports represent domestic demand, but we hesitate to read much into it: Most of the growth stemmed from an abnormally strong April, boosted by aircraft deliveries and crude oil imports (more on this shortly).^[v]

Look, growth is growth. Whatever the contributors, UK GDP has recovered from late-2023’s slide and is at new highs. Higher wage growth is supporting consumption and, with pay gains outpacing inflation, gradually helping consumers overcome elevated prices. Nothing in this report suggests to us that UK stocks were wrong to price in an improving economy this year. But when the government is such a large contributor to growth, we think at least a pinch of scrutiny is in order.

Not only might high public spending and investment represent less-efficient use of funds and resources than might happen if it were households and businesses directing traffic, but public contributions are volatile. The new government has already slashed several planned investments and spends. You are welcome to debate amongst yourselves whether this is a net positive that creates more room for private investments to fuel growth—or a sign of long-term decline. But it seems clear to us, particularly as Chancellor of the Exchequer Rachel Reeves talks of budget holes, that it would be unwise to extrapolate Q2’s big public spending and investment growth forward. The private sector will need to do the heavy lifting. It can, and again, UK markets suggest it will. But investors benefit from keeping measured, realistic expectations.

Thankfully, judging from extant gloom over monthly GDP, measured expectations probably won’t be a problem. A lot of folks expected GDP to grow in June, boosted by the start of Taylor Swift’s swing through the country and increased pub footfall as England kicked off its run at the Euro 2024 soccer tournament. But it flatlined after May’s 0.4% m/m growth.^[vi]

Under the hood, things were mixed. The production sector grew 0.8% m/m as manufacturing’s 1.1% growth more than offset mining and quarrying’s -4.0% fall.^[vii] The latter stemmed primarily from oil and gas extraction’s -5.3% m/m drop, extending not only a rough year for the industry but also a long-running decline.^[viii] Perhaps June’s outsized fall was exacerbated by regulatory uncertainty during the general election campaign and talk (which has since come to fruition) of the windfall profits tax getting more teeth. But we wouldn’t read much into it, given the long-running trend. Mostly, we think the continued decline adds more context for the aforementioned oil import surge. That is a tradeoff, and one politicians are wrestling with.

More importantly, services output fell -0.1% in June—a not-great result for the sector that generates the vast majority of UK GDP.^[ix] Defying predictions of Swifties and soccer fans turbocharging growth, wholesale and retail trade (including motor vehicle repair) fell -1.0%.^[x] So did accommodation and food service activities. But is this weakness? Or is it a modest letdown after a gangbusters (sorry) May fueled by wonderfully warm weather? And what role did June’s renewed rain play?

The fact that we must ask all these questions hints at the drawbacks with monthly GDP. We think it is very nice of the ONS to produce it. We love data and details! But every month has its share of twists and one-offs, which introduces variability and makes the trends harder to see. Winter-esque rain in June can wreak havoc with seasonal adjustments. So can big one-off events that don’t happen annually. Therefore, we don’t think it is fair to project June’s flatness forward, either.

For stocks, this is all backward-looking. Markets pre-price expected events about 3 – 30 months ahead. We are now at mid-August, with markets probably looking to late 2024 and 2025. Whatever happened in April, May and June is old news to stocks, which likely moved on them long ago. What matters from here is how future growth meshes with expectations. Economic sentiment may have warmed lately, but there are still plenty of people looking for clouds in silver linings instead of the reverse. Official forecasts, while revised up, aren’t off the charts. And mass sentiment still presumes a legit UK expansion depends on the Bank of England cutting rates further from here—even though GDP bounced to new highs before August’s first rate cut. Therefore, we see plenty of room for reality to meet or exceed expectations.