A preliminary estimate by the Office for National Statistics (ONS) suggested the economy grew by 1% over the third quarter, better than economists expected and bringing to an end the recession that persisted over the previous three quarters.
This is undoubtedly good news, at least on the surface. Macroeconomic consultancy Capital Economics described the figures as a “welcome surprise” while Azad Zangana, European economist at Schroders, said they show the UK left its recession “in sensational style”.
However, whether this good news will persist is another matter entirely. A number of commentators, including Zangana and Capital Economics, warned that the UK is at risk of a “triple-dip” recession, while other evidence shows individual companies continue to struggle.
Economy remains weak
Asset allocators should be wary of focusing too much on last week’s GDP rise, no matter how positive the headline figure may appear. The bulk of its strength came from factors like Olympic ticket sales and a bounceback from extra bank holidays earlier in the year – which are temporary and will mean the fourth quarter’s growth appears weaker.
Other economic indicators, such as the Confederation of British Industry’s Industrial Trends Survey and purchasing managers’ indices (PMIs) by financial information services company Markit, suggest underlying growth in the UK economy remains weak.
Vicky Redwood, chief UK economist at Capital Economics, said: “There are still a number of constraints on the recovery. As the Olympic effects unwind, it is still possible that the economy contracts again in Q4.”
Companies remain downbeat
On a company level, things are not terrible but certainly could be better. Markit’s PMIs, which are based on surveys conducted among businesses, show the manufacturing sector remains stuck in contraction and the country’s dominant service sector is struggling to grow.
Firms are also lowering their profit expectations. Ernst & Young’s latest Profit Warnings report show that 68 UK-quoted companies issued profit warnings in third quarter – one-third more than in the same quarter of 2011 and the highest third-quarter total in four years.
Keith McGregor, head of restructuring for Europe, Middle East and Africa at Ernst & Young, said: “While some profit warnings from consumer facing sectors blamed the poor weather, the underlying weakness of the UK economy and global growth concerns landed the heavier blows to profits and expectations.”
UK equities and the rest of the world
It must be remembered that the fortunes of UK businesses are tied up to conditions on the global stage and not just the domestic front. When considering UK investment opportunities, the health of the rest of the world must be factored in alongside the country’s own GDP data.
Andrew Bell, CEO of Witan Investment Trust, agreed: “The UK stock market’s fortunes depend more on the health of the world economy than the domestic scene. Here, there are some hopeful signs from US housing, the Chinese cycle bottoming, lower oil prices and reduced fears of a European financial collapse.”
But it would be wrong to think the global economic picture is completely rosey. Despite some bright spots, risks persist such as the ongoing eurozone debt crisis, uncertainty over the effects of the US fiscal cliff after the presidential election and slowing global growth.
So, time to get bullish on the UK?
While last week’s GDP numbers could mark a turning point for the UK economy, this fragile situation may be reversed next quarter or at the start of 2013.
Rupert Watson, head of asset allocation Old Mutual Wealth Management, said headlines that economy has left recession could lead to a short-term boost in investor sentiment and UK equities.
However, he added: “The ONS would say that financial market participants should not be relying overly on this one single measure to determine investment strategy and that it is but one of a number of measures and you should look at all of them.”
Bear in mind that with continued uncertainty at almost every level – from the accuracy of economic figures to if the US fiscal cliff can be avoided – equities will remain somewhat divorced from fundamentals and continue to trade on newsflow. The GDP estimate will soon be drowned out by other news, in other words, be that good or bad.
Changing allocations on the basis of one bit of good news, no matter how seductive, is never a good idea. Last week’s numbers should offer investors hope of coming recovery, not prompt swings in strategy.
