UK Economy No Longer in Recession

Market Review: It was another good week for global financial markets, which seem to have a bullish spring to their step at the moment. Strangely, I have barely heard the old adage, ‘sell in May and don’t come back till St Ledgers Day’. This may reflect the more positive tone in sentiment or the fact I am getting older and there are few of us dinosaurs left that remember the old adages! For a while now, the UK has outperformed the US and whilst it is far too early to declare the period of American exceptionalism over, it is welcome relief to us UK investors who typically hold a higher weighting in our own domestic market than benchmark MSCI World Index weightings. Europe joined the UK at the top of the weekly table and Chinese equities continue to enjoy their own renaissance. Bonds were remarkably flat.

UK Outlook

In the absence of any major piece of economic news coming out of the US, I thought I would focus on the UK market this week, where we not only got to hear from the Bank of England but we also got the release of first quarter UK GDP. General consensus suggested we would get confirmation that  the economy had moved out of recession and the data release didn’t disappoint, coming in right at the top end of expectations. GDP actually jumped 0.6% in the first quarter compared to the previous three months, as customers returned to shops spending their higher wages and investment rose again. Besides the gains in retail sales and investment, output improved with fewer strikes in the health sector. Growth in the month of March alone was 0.4%, well above expectations due to a jump in both services and manufacturing.

While stronger-than-expected growth could complicate the Bank of England’s path toward a potential rate cut this summer, the central bank, who would have had prior indication of the higher GDP print, set a dovish tone on Thursday as they kept interest rates on hold. In fact, after setting the stage for rate reductions in February and edging closer in March, this month saw the MPC advance even further along the path to rate cuts. While the policymakers did not explicitly signal impending actions, their statements suggest an increasing probability of rate cuts which could come as early as June. Now only with a 7-2 majority, the MPC opted to keep the Bank Rate steady at 5.25%, with Dave Ramsden now supporting a 25bp cut. Additionally, the introduction of new phrasing in the policy’s final paragraph ‘the Committee will consider upcoming data releases and their impact on the inflation risk outlook’ it implies that the Bank of England have now paved the way for easing, when the numbers confirm.

That statement will increase market scrutiny on the two sets of inflation and wage data that are due to be released before the bank’s next meeting. Some economists have said that inflation could dip below the 2% target during that period lending credence to the view that the first rate cut could come as early as June. Regardless of the timing, I suspect that going forward they will then pursue a ‘cut and wait’ policy rather than prescriptive cuts. Nudge them down, check inflation is still behaving and if it is ,then nudge them down again,  but reserve the right to put the brakes on at any time if inflation or wage data , misbehaves.

There was also the encouraging news that the BOE has raised its forecast for an improvement in living standards, with average wage growth of 5.25% this year, well above inflation. It may not feel like it for many people challenged by higher mortgage repayments, but with real post-tax household income in aggregate expanding by 1.75% this year, it will be well above the 2010-2019 average.

So, with an usual dose of good economic news, a central bank prepared to cut even as growth forecasts are lifted higher, perhaps we shouldn’t be surprised to see the UK stock market breaking new ground, with the FTSE 100 sitting comfortably above 8,000. The investment case for buying UK equities has historically largely been predicated on the simple belief that it is a cheap market with a good dividend yield, but now it would appear to also offer better earnings growth prospects. Corporates have already spotted the opportunity with a significant increase in M&A activity, with bids coming in at significant premiums to quoted prices.

There are already signs that the good news coming out of the UK has begun to attract global investor interest, with many institutional money managers looking around for better value opportunities outside of the US. We have even tentatively seen the UK sector begin to outperform the US over the last few months. For any of you who may feel that you might have missed the boat on the UK, I will offer the following chart which I confess did surprise me. It shows the relative performance of the IA UK All Companies Sector vs the IA North American Sector over the last 10 years. Whilst I knew the UK had underperformed, I had no idea as to the extent……!

Now, if the UK equity market was merely made up of companies that operated in domestic isolation, it would perhaps be possible for this trend to continue indefinitely. But that is not the case, a large proportion of our large and mid cap and even many of our smaller companies derive a significant amount of their revenue overseas and their valuations can be directly compared to US equivalents. Given that US equivalents can trade as high as double their UK counterparts, I see the playing field levelling from here. I am not saying that the UK market should trade on comparable multiples to US companies, there are many reasons why American businesses justify a premium, but I think the valuation disparity is too great and the gap will narrow from here. For the first time in a very long time, I think that having a higher weight in UK equities than the benchmark MSCI World Index weight (circa 4%) makes sound investment sense.

Let’s hope for another good week for financial markets and we will return to a more US centric market matters next week as there will be plenty of releases to chew over, with the big ones for inflation, retail sales, and production. I sense the market could find these a bit challenging as on balance they could look a little stagflationary – stubborn inflation and slowing growth. We will see what investors make of the figures, to be fair the market is probably due a breather after a strong run up, with the Dow Jones having been up the last 8 days.