9th July 2013
In tennis as in the economy, the UK has got so used to seeing itself as the loser, and it doesn’t quite know what to do with itself when it starts to win writes Cherry Reynard. The UK economy may not quite be a Wimbledon champion yet, but there are signs it is improving and investors may not yet have adjusted their expectations.
The headline figures for the UK economy still look unexciting. At the end of June, the Office for National Statistics reported GDP unchanged for the first quarter. New Bank of England Governor Mark Carney was unequivocal in ruling out an early rise in interest rates, suggesting a change in monetary policy was “not warranted by the recent developments in the domestic economy” as the Evening Standard reported.
However, there is an increasing weight of opinion suggesting that a) the statistics are flawed and b) that the second half of the year may be significantly better.
The main theory behind the idea that the statistics are flawed is that employment and GDP growth figures do not agree. The UK employment figures are improving, but this is not being reflected in GDP figures. This suggests that productivity is weakening, or the statistics are wrong.
Richard Woolnough, manager of the M&G Optimal Income, Corporate Bond and the Strategic bond funds, says: “Since 2010, the relationship between GDP and employment has broken down. Everyone assumes that the GDP figure is right, but what if there is something wrong with it? Personal insolvencies are at all time lows, car sales are at record highs. All the other evidence suggests that the UK economy is not that weak. There are the same number of people working as in 2007, yet they are apparently 5% less efficient.”
He suggests that if the data is flawed, it is easy to make policy mistakes and investors may find that inflation surprises on the upside. Across his portfolios, he is short of duration (interest rate sensitivity) and long of credit risk as a result.
Woolnough is not alone in seeing flaws in the data. Cazenove’s chief investment officer Richard Jeffrey has consistently pointed out that GDP estimates may be flawed and may not take into account highly productive parts of the economy, such as some smaller businesses.
However, flawed or not, there is also a significant body of experts who believe that the official statistics may be revised higher in the second half of the year. The recent ONS figures showed a subtle but important revision to the underlying components of GDP. As Sarah O’Connor writes on Ft.com (behind paywall), “The ONS had originally thought GDP was boosted by companies building up their stocks in the first quarter – a somewhat flimsy foundation for further growth. On Thursday it attributed much of the increase to net trade instead. It said net trade added 0.6 percentage points to growth, having subtracted 0.3 percentage points in the previous quarter, as imports fell faster than exports. Meanwhile, household spending grew 0.3 per cent, more than previously estimated. Investment rose slightly after three successive quarterly falls, thanks to a large increase in private sector housing investment.”
The housing market – important for overall economic confidence – appears to be picking up: Bill McQuaker, head of multi-asset at Henderson Global Investors, says: “Investors could be underestimating the impact of some of the coalition government’s initiatives to kick-start the economy. Extra assistance for home buyers through the Funding for Lending and Help to Buy schemes appears to be feeding through to the housing market. According to the latest figures from the Council of Mortgage Lenders banks lent more to would-be homeowners in May than at any time since the autumn of 2008.”
He believes that sterling weakness has been beneficial to Britain’s manufacturers, who have been enjoying a stronger-than-expected rebound in business. This is supported by the most recent purchasing managers’ data, which showed the UK manufacturing and service sectors growing at their fastest rate for two years. Survey data from the British Chambers of Commerce also showed that the number of companies reporting rising exports rose to a record high in the second quarter. Dollar strength if the Federal Reserve pares back quantitative easing may accelerate this trend. It all points to a stronger second half for the UK economy.
Fund managers have started to look more domestically in their stock selection in anticipation. Tim Steer, manager of the Artemis UK Growth fund, has been concentrating on UK equities with significant overseas businesses for around eighteen months, but is now re-orientating his portfolio to domestic stocks as trade website Fundweb reports. David Taylor, manager of the Chelverton UK Equity income fund, has also switched his portfolio bias on the basis of the UK’s changing economic fortunes. The better performance of UK-orientated companies can also be seen in the on-going outperformance of the mid-cap sector.
If economic growth does surprise markets in the UK, investors will also need to have sufficient inflation protection in their portfolio. It is certainly another nail in the coffin for non-inflation linked bonds and cash.
However, one final note of caution comes from Ruth Lea, director and economic adviser at the Arbuthnot Banking Group. She says: “The new Bank of England Governor is relatively fortunate to have taken the helm when the economic indicators are beginning to look more encouraging. But we must not get carried away with the good news. GDP is still about 4% below the pre-recession peak and public spending, despite all the rhetoric about austerity, continues to grow inexorably. Many hard decisions will still have to be taken to finally get a grip on the public sector’s size and finances.”
In other words, the UK isn’t perfect. But then everyone knew that. The question is not whether the UK economy can be the equivalent of Andy Murray, but whether it can defy those who still believe it is a dead man walking.