Investing in a recession

25th July 2012

Although the figures make clear that the recovery from the financial crisis is likely to be a painful and protracted one, they actually tell us very little about the health of the corporate sector. Evidence for this can be seen by looking at the performance of the FTSE 100, which to the time of writing has been trading largely flat since the news was announced this morning.

What, then, do the numbers tell us?

Firstly, it is important to remember that at this stage they are estimates. Most of the actual data for economic activity over the period has yet to be collected and collated by the Office for National Statistics.

This means that there is a good chance the 0.7% contraction could be revised, although it is as likely to be revised up as it is down.

Secondly, the biggest contributor to the fall in activity came from the construction sector. The ONS estimates that construction output fell 5.2% over the quarter.

The problem with the figure is that construction is prone to large swings in activity. This means that ensuring the reliability of estimates is particularly challenging.

The ONS arrives at its preliminary figure by using published data for months one and two alongside an estimate for month three. The latter is based on the historical difference in activity between, in this case, May and June. If firms have an anomalously good or bad June then these early numbers will not reflect the reality on the ground.

So it is important to keep a healthy degree of scepticism over the figures. With unemployment falling for the fourth straight month in May, bringing the total number of people out of work down to its lowest point in over a year, there are good reasons to doubt the estimate.

To their credit the ONS have acknowledged that the reality may have been better than the estimate suggests:

"The bottom line from all this is that the underlying performance of the economy was probably somewhat better than the headline figure of -0.7% would suggest, having regard to the extra bank holiday and to the poor weather," Joe Grice from the ONS told the BBC.

"How much that effect might be is something we won't be able to say or to quantify until we have further experience against which to judge."

That said it is highly unlikely that the final figure will show that the UK economy grew in the three months to the end of June. Ongoing sovereign debt troubles in Europe and bank deleveraging are providing strong barriers to meaningful growth at present. Few expect either of these problems to go away quickly.

How should investors respond?

One option is to do nothing. There are few surprises in this latest round of bad news and no new threats to companies in the immediate future. If economic activity continues to contract then it would bode ill for consumer facing firms but the effects should be gradual rather than dramatic.

Summing up the news Keith Wade, Azad Zangana and James Bilson, economists at Schroders, said in a note:

"The recovery has been described as BBB – bumpy, brittle and below par – but no one should be surprised as this is typical following a financial crisis, not least one on the current scale. Recent data suggests we have just hit another bump with business surveys indicating that the world economy has stalled."

The worry, as they identify, is that Britain has become the laggard of the global community underperforming the US, Japan and even the eurozone. This, however, is predominantly a concern for the government whose economic credentials are being sorely tested by yet another setback to their promised recovery.

 

More on Mindful Money:

The UK is in a depression

Should we give up on pensions?

The Kay Review: What investors need to know

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The Financialist

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