In this episode we discuss an improving UK economic outlook, but with labour market uncertainty.
The UK reported a record 20.4% slide in real GDP decline in the second quarter of 2020 as government lock-downs to limit the spread of the coronavirus took their toll. This was the worst decline on record.
However, as many lock-down measures have been lifted, the more recent monthly data showed a significant improvement in June, an encouraging sign that the economy is moving in the right direction.
August has a few anniversaries in British history: the 400th anniversary of the Mayflower’s departure from Southampton; the 75th anniversary for Victory in Japan in the UK and the 250th anniversary for when explorer Captain James Cook claimed Eastern Australia for Great Britain. Let’s talk about another date, 12 August, that might be a future candidate.
- Yes, this was the day the UK reported a record non-annualised 20.4% real GDP decline in the second quarter of 2020(1), in response to government lockdowns to limit the spread of the coronavirus.
- This is the worst decline on record
- we make four observations from the GDP data:
- first, the previous worst decline (-12.2%) occurred during the third quarter of the 1921 recession, as the country struggled in its transition to a peacetime economy from the first World War and from the Spanish flu influenza pandemic that lasted until 1920(2)
- second, GDP has fallen to a level last seen in 2002, so effectively erasing 18 years of growth(3)
- third, the fall was four times deeper and six times faster than during the Global Financial Crisis; and
- the quarterly GDP decline was more than twice that of the US and worse than all other EU member states.(4)
We knew things would be pretty bad – was this worse than expected?
- To some extent, yes
- the UK’s poor relative economic underperformance was largely due to the length of the lockdown, which was necessitated by our densely populated country and the slow initial response of the government;
- for instance, non-essential shops closed for 84 days in the UK, compared to 30 days (Germany), 55 days (Italy) and 58 days (France).(5)
How is the future looking? V-shaped? L-shaped? W-shaped? What are your assumptions moving forward?
- The second quarter UK GDP data is now history
- as many lockdown measures have been lifted, the more recent monthly data showed an 8.7% real GDP rise in June which is an encouraging sign that the economy is moving in the right direction;(6)
- The Bank of England expects GDP growth to be only 5% below the level of a year ago by the fourth quarter.(7)
How much of this is stimulus measures? And is there a danger that it evaporates once those measures are withdrawn?
- There is evidence that simulative policy actions are feeding through to the economy, and particularly in the important residential property sector
- Chancellor Rishi Sunak’s decision to raise the stamp duty threshold from £125k to £500k, has seen a record number of new home buyer enquiries in July, according to the Royal Institute of Chartered Surveyors housing survey.(8)
- the eat out to help out scheme, which offers 50% off for people eating out from Monday to Wednesday in the month of August, also provides a much needed boost for restaurants;
- high frequency data from Open Table, a restaurant booking app, shows that restaurant bookings has recovered to the same levels last year, a quick turn-around after lockdown was lifted.
What does this mean for the UK stock market?
- As it stands, a recovering UK economy is being reflected in higher projections of company earnings: the consensus now forecasts +2% Earnings Per Share growth over the next 12 months, a sharp reversal from a -14% projected decline at the end of May(9)
- the improving fundamental backdrop has helped lift the MSCI UK benchmark equity index by 25% from its low in March;(10)
- even after this rally though, UK stocks are still down 16% since the beginning of the year, weighed down by dividend cuts, uncertainty over Brexit and its relatively more difficult coronavirus experience.(11)
Does that make them cheap relative to international peers?
- Most definitely, a key test will be how the economy fares as the government reins back policy support for the labour market
- this has already started with the Job Retention Scheme being scaled back in stages
- employers will now have to pay pension contributions and National Insurance for furloughed workers in August, 10% of wages in September, rising to 20% in October when the scheme finally ends
- it is not clear how many furloughed workers will lose their jobs and what impact this would have on the recovery.
Let’s turn to the US. Investors are currently focused on the election, but is there anything else they should be worried about?
- Across the pond, investors have shrugged off higher coronavirus new cases as well as selective retightening of restrictions in many states plus the start of the US November election campaign where Joe Biden is currently favourite
- the S&P 500 is up over 50% from its low in March and trading close to an all-time high thanks to the dominance of the big five technology companies(12)
- improving economic activity and labour data, better than expected company earnings in the second quarter, hope for a future COVID-19 vaccine and a super-dovish Federal Reserve have all contributed to US stock returns, and particularly the Big Tech stocks
- nevertheless, given that an increasing share of personal income is made up of federal stimulus payments, investors are perhaps a little complacent about the risk of a so-called “fiscal (aka benefits) cliff” that could undermine the economic recovery
- a bipartisan agreement in Congress to pass a second stimulus program is widely assumed;
- President Trump’s recent executive orders to bypass Congress and provide coronavirus relief funding should be viewed as only a temporary fillip for the economy.
And what happens if it’s not agreed?
- The available cash for additional unemployment insurance will only last around a month before it runs out and it is unclear whether his plan of a payroll tax deferral (note it is not a tax cut) will encourage consumers to spend more
- it is not certain whether the President’s unilateral action has helped negotiations in Capitol Hill or delayed them, as it lessened the need for urgent legislation before the holiday break
- the bottom line is that without additional government stimulus, US household incomes could fall like Wile E. Coyote chasing the Road Runner off a cliff in a Looney Tunes cartoon
- under that scenario, the US recovery could come to an abrupt halt and put downward pressure on equities more broadly.
(1-4 & 6-7) Bloomberg, data as at August, calculations by Smith & Williamson Investment Management
5() IMF, Ourworldindata.org, as at August 2020
(8-12) Refinitiv datastream, data as at 24 August 2020
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This episode was recorded on 26.08.2020
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