February 10 2023
The preliminary release for fourth quarter GDP in the UK showed that the UK economy stalled in the period. Although third quarter figures were revised down, showing a contraction of -0.2%, the flat figure meant that the economy narrowly avoided recession. A recession is classified as two consecutive quarters of negative growth.
The service sector was flat during the month, with a pickup in construction offset by a fall in production and there was a pick up in imports whilst exports declined. Monthly figures however showed that GDP fell 0.5% in December and it may be this figure which investors will monitor to see if it extends into the first quarter of 2023.
It is estimated that the economy grew by a total of 4% in 2022. This was stronger than all other countries in the G7, with Japan yet to release data. The G7 includes the UK, US, Canada, France, Germany, Italy and Japan. Despite this, the UK economy still remains 0.8% below, and, is the only member of this group not to see its economy now higher than the Q4 2019 pre-pandemic level.
In the UK we also saw a rate increase, a move of 0.5% which takes the base rate to 4%, the highest level we have seen since 2008. Whilst further rate increases are still expected, potentially peaking at 4.5%, it was noted that the Bank of England had dropped the pledge to keep increasing interest rates forcefully. They also added some comfort regarding inflation, commenting that it had likely peaked. It was these two comments which the market seized upon and at the time of writing the 10 year gilt trades at a yield of only a little over 3%. To place this in context, on the 3rd January the yield closed at 3.65%.
The weaker economic data perhaps begs the question why the UK equity market has performed not to shabbily over the last 6 months and in particular since their end of September/beginning of October lows. All UK equity fund managers we have spoken to agree the UK stock market is not the UK economy. This is particularly pertinent when talking about large cap stocks, where in October last year FTSE Russell estimated that 82% of FTSE 100 revenues are from overseas markets. Although the drop is sizeable, the figure is still a reasonably high 57% for the FTSE 250.
Currency movements therefore, in particular sterling against the US dollar, can have a significant impact on reported earnings, with weakness in the former being a benefit to higher earnings. The same is also true for dividends, with some companies reporting theirs in US dollars. UK equity managers also point to the lower valuation level which the UK market trades at, relatively to its own history and other markets around the world.
In the US, economic data has been thin on the ground this week, but that is perhaps not a bad thing as the market continued to digest the unemployment which we saw Friday last. Here we saw 517,00 jobs added which was way above the consensus forecast of 185,000. The unemployment rate, meanwhile, fell to the lowest level seen since 1969 of 3.4%. The market continues to price in the potential for interest cuts in the US, despite comments from Federal Open Market Committee (FOMC) members such as “there is still a lot of work to do” to bring inflation under control, “we may have to raise rates more than is priced in if we continue to get strong labour market reports or higher inflation”, and, “there’s not much evidence, in my judgement, that rate hikes we’ve done so far are having much effect on the labour market, we need to do more.”
US treasury yields are a little higher on the week, but the market still believes that we could see interest cuts in the US by year end, whilst the FOMC believes that this is not the case. Someone will end up disappointed.
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