Thursday, 25 April 2013

UK GDP: (not so) Deeply Dippy


Source: ONS/Brewin Dolphin
The Office for National Statistics reported this morning that Gross Domestic Product (GDP) grew by a lacklustre 0.3%. This was ahead of the market’s expectation of just 0.1%

GDP is the generally accepted gauge of how an economy is performing. It informs us of how rich we are as a country and, by dividing GDP by population, gives the measure of GDP per capita which gives an indication of standards of living. Furthermore it reflects the size of the assets against which our national borrowing can be secured. Therefore measures such as budget deficits (net new borrowing each year), national debt (total outstanding government debt) and external debt (debt owed by government, companies and households to foreigners) are all expressed in terms of GDP. This makes sense because GDP can also be taken as a crude proxy for the activity against which the government can levy taxes.

Following on from the fourth quarter of 2012’s -0.3% dip, a further negative reading would have been classed as a recession. The line between no growth and recession is infinitesimally small from an economic perspective – particularly given the lacklustre rate of growth seen in recent years – so this distinction matters more for the media and politicians than for investors. To talk about single, double or triple dip recessions suggests some sort of equivalence between slowdowns. In fact they are of massively different magnitudes. Nevertheless avoiding the triple dip certainly feels good.

The measurement of GDP marries several components which help us to understand why growth has been so weak. Using the expenditure calculation method, GDP is the sum of consumption, investment, government spending and net trade (exports less imports).

Ordinarily government spending rises during economic slowdowns and falls as the economy recovers. This effect is largely caused by unemployment benefits and is helpful in smoothing the pace of GDP growth. The cyclical fluctuations in unemployment benefits are therefore known as ‘automatic stabilisers’ for an economy. Beyond these cyclical components, however, the political consensus is that public finances need to be reigned in, with a rabid debate ongoing about the pace of that adjustment.

Government spending, therefore, is unsurprisingly not making a huge positive contribution to the growth of GDP.

Consumption has been the most consistent provider of growth in the post-financial crisis world. It has, however, also been below the pre-financial crisis trend. Partly that’s because of the ongoing process of deleveraging, by which we mean, raising savings rates. Households have felt inclined to rebuild their home equity, having used that equity in previous years to fund consumption. The policy response has been to lower interest rates, thereby discouraging saving and encouraging borrowing.

This policy has unleashed the forces of financial repression. As we have commented before, these have seen inflation rise above rates of return available on low risk investments and above the underlying rate of wage growth. Overall, however, while the policy does discourage bank saving, it is not greatly encouraging for consumption, because it reduces spending power. Perhaps, on that basis, we are surprised to see any positive contribution from consumption over recent years.

Part of the explanation has been that the UK’s employment performance has actually been quite strong. The UK added half a million jobs in 2012 alone and so, even with financially repressive take home-pay, there is clearly going to be a positive contribution to consumption.

Lower interest rates and quantitative easing have seen the pound fall around 15% on a trade-weighted basis over recent years. The hope was that the weaker currency would see exports rebound and imports fall – providing a net trade boost to GDP. Trade, however, has been an ongoing disappointment for the UK. This is because Britain’s largest trading partner, the eurozone, has turned in an even more woeful economic performance than the authorities had projected, and now remains in something of a prolonged slump.

Here the UK now needs to re-orientate itself towards countries which have better growth prospects and there is a reasonable case for believing that these come from the emerging world. This has been one of many differentiators between the German economic success story (admittedly showing signs of faltering now) and the UK’s tale of relative woe.

Bizarrely this should not be seen as unequivocally bad news for UK equities. The financially repressive monetary policy operates by encouraging investors to flee low yielding ‘safe’ assets and invest their funds more profitably. That should mean short-term gains but long-term pain as the distorting policy is eventually removed. At the moment, however, dividend yields remain in line with historic averages suggesting no great concern over elevated valuations.

Weak economic growth, therefore, lowers bond yields and thereby discourages investors from holding their cash in anything other than shares. The question is whether the same forces reduce the potential return on shares. Here the picture is more optimistic as the eurocentric focus of UK exports is not shared by the focus of FTSE 100-listed UK company revenues. These are directed more towards resilient areas such as Asia and the US.


Guy Foster
Head of Portfolio Strategy

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