How Bad is the UK Downturn Going to Get?

So maybe things will not be as bad as predicted, let us hope so.

Welcome to Money Distilled. I’m John Stepek. Every weekday I look at the biggest developments in the world of markets and economics, and explain exactly what it all means for your money.

I want to hear from you, so send your feedback, opinions or questions to me at jstepek2@bloomberg.net. I plan to print the best comments every Friday, so if you’d rather I didn’t consider you for publication, then please make that clear, or else I’ll assume you’re happy to see your name (or email pseudonym) in lights.

And if you haven’t already, sign up here to make sure you get Money Distilled delivered to your inbox everyday.

How Bad is the UK Downturn Going to Get?

One of the biggest disconnects between mainstream news coverage of markets and economics, and markets themselves, lies in the attention paid to economic growth and GDP statistics.  

Specifically, the word “recession” will garner news headlines across the board almost any time it’s mentioned, whereas in markets, it’s generally greeted with a shrug. 

This is because markets are forward-looking, whereas economic data is backward-looking. By the time we can confirm that we’re actually in a recession, markets — if they’re performing as hoped — should already be starting to price in the recovery. A recession is not news. 

The papers, on the other hand, relish the drama of the “r” word. So you hear about it as soon as anyone forecasts it; you hear about it the minute someone confirms that we’re actually in one; and you get endless coverage of what exactly a “technical” recession means, and how much worse ours is going to be than anyone else’s ever (if you live in the UK, at least).  

In your role as a participant in the “real” economy — ie someone with a job and maybe a mortgage — recessions matter. But if you’re likely to bear the brunt of one, you’ll hear about it well before the newspaper starts reporting on it. 

In your role as an investor, however, the important thing is not so much the recession, as how bad a recession is priced in. This is what I’m trying to consider now, in relation to the UK.    

The UK is a consumer-driven economy. Long story short, if people stop spending, our economy is in trouble. That’s the main thing driving concerns about recession. There is no doubt that the consumer is facing some serious pressure. 

We know that the UK, like much of Europe, is facing a tough winter. Energy bills are much higher than they were, and that will likely remain the case for some time. Mortgage costs have shot up substantially compared to this time last year, or even six months ago. Businesses are seeing their costs rise too. This all acts as a drag on the economy. 

But at the same time, we are aware of all this. The energy bill issue has been around for some time and has been at least partly dealt with by the government. By now, anyone who is sufficiently concerned should have a good idea of what their energy bill will be for the next five months.    

As for mortgages, the irony is that the “short sharp shock” we’ve seen might be the healthiest way for the property market to adjust. Anyone who was in danger of jumping on the ladder, in the expectation that rates would remain low for years, has been prevented from doing so.

Meanwhile, mortgage rates are now actually going down from the worst of the peak. So it might turn out that the genuinely vulnerable portion of homeowners is smaller than it otherwise could have been with a more gradual ratchet higher.  

Consumer Cope

So how is the consumer coping right now? The latest figures for mortgage approvals, savings rates, and credit card lending came out from the Bank of England this morning. The tale they tell is interesting, but not conclusive. 

The mortgage figures are entirely unsurprising. The number of approvals for new house purchases fell sharply. That’s clearly because a lot of people would have cancelled deals (voluntarily or involuntarily) in the wake of the late-September mortgage drought.

Consumer credit (including credit cards, personal loans, and car financing) grew by a little less than expected, but nothing to write home about — and credit card spending was in fact quite a bit higher than last month. The cost of personal loans rose notably, which is again what you’d expect given the general rise in interest rates. 

Perhaps the most interesting shift was in savings. There was a record inflow (records starting in 1997) of £11.3 billion in savings into fixed-rate savings accounts. I can’t help but feel that a sizeable chunk of this was probably driven by people whose housing transactions fell through — those deposits have to live somewhere. And of course, it helps that interest rates on savings also went a lot higher last month (though not as high as mortgage rates, of course).  

You can spin a line about these data that makes a bearish or a bullish case, but I don’t really see much of a clear story here beyond the housing market disruption. 

What about corporate news? Flooring specialist Topps Tiles Plc just reported record revenue for the second year in a row, for the year ending October 1. Profit was down due to rising costs, but like-for-like sales in recent weeks are up 3.4% year on year and trading is currently “robust.”

Budget airline easyJet Plc meanwhile is also struggling on the cost side, but is still expecting a busy spring. Convenience food group Greencore Group Plc was a little cautious on the outlook for 2023 after a strong year, but it still noted that revenue “has broadly held up” and again, it comes across that the biggest challenge it faces is cost inflation rather than demand. 

I have to say that if you didn’t know about the cost-of-living crisis, your first thought on reading these corporate results wouldn’t be “oh, we’re definitely in a recession.”

Work Matters

What really matters in the longer run, in terms of the depth and length of any recession, is the labor market. 

If people remain in employment, then they keep getting paid, and they can generally soldier on. If they can’t get inflation-beating pay increases, they may have to cut back, or they may end up borrowing more money. But the most disastrous personal outcomes (bankruptcy, losing a home, stress-induced divorce) are avoided. 

The only problem, of course, is that unemployment is a lagging indicator. It doesn’t generally turn up until everything else has gone pear-shaped. 

But even then, despite rising costs, companies don’t seem to be gearing up for major layoffs. I had a chat with Scott McKenzie, a fund manager with Edinburgh-based boutique asset manager Amati Global Investors yesterday. He talks to a lot of small and mid-sized domestically-focused UK companies, which was one of the reasons he was down in London. I asked if anyone had been talking about layoffs recently and he couldn’t think of a single example.  

There is an argument here that the inflationary backdrop means that companies will be inclined to hoard labor, even if there is a downturn because it was so hard to get hold of workers in the first place. 

Look, I’m not saying it’s all sunshine and roses out there. And this is the sort of macro economy that none of us has really encountered before. The pandemic wasn’t entirely unique but our response to it was. And inflation is a macro phenomenon essentially unknown to anyone whose adulthood began in the 1990s.

I’ll be canvassing other views on this and looking through the various investment bank outlooks over the next few weeks. But for now, it’s not at all obvious to me at this stage that we’re facing anything more than a relatively mild recession.   

And on that front, what really matters to my mind is that UK stock markets, particularly the domestic-facing stocks, appear to be pricing in a pretty significant downturn. UK small caps have had an absolute shocker of a year. As of the start of this month, UK small caps were trading at their lowest price/earnings multiples since March 2020, the worst of the pandemic panic, and before that, the years of the eurozone crisis.

In other words, investors are currently placing about as much value on future small-cap earnings as they did when they were panicking about the global economy shutting down, or Greece unleashing a domino effect that would result in the euro’s demise.

Even if we’re facing a much bigger recession than it currently “feels” we are, that seems overdone. 

From....https://www.bloomberg.com/news/newsletters/2022-11-29/how-bad-is-the-uk-downturn-going-to-get