UK GDP shocker, in Draghi we trust, and UK banks to watch

It was another record-breaking week for US stocks, which ended on a high note today. There was also signs that the good times will continue, as investors poured a record $58bn into global stock funds last week, according to the latest EPFR data. The US had the bulk of inflows, attracting more than $36bn. US technology focussed funds are at the centre of the rush into stocks and risky assets, as investors pulled more than $10bn out of cash funds. We have mentioned that the trend for outperforming US indices and the US tech behemoths, in particular, remains in-tact as we progress through Q1, and the desire to own the big US tech names is likely to continue. Global bond funds are also enjoying a surge of inflows, with more than $13bn of inflows last week and investors seem comfortable with the riskier end of the bond market. Benchmark US Junk bond yields fell below 4% for the first time this week, highlighting the depth of demand. Added to that, some of the most beleaguered economies in Europe are also experiencing a surge in demand for their bonds. There was more than EUR 65bn of interest for a EUR 5bn bond sale by the Spanish government this week, while Italy’s bond yields have fallen to record lows as former ECB head Mario Draghi prepares to become Italy’s latest Prime Minister. 

Why UK GDP was not all bad news 

In this environment of ‘risk on’ on steroids, it’s easy to think that the fundamental data does not matter. It does, at least in the long term. UK GDP for 2020 looked horrendous, as expected, a near 10% fall in output for the year as a whole, which is the deepest decline for 300 years and the equivalent of more than £250bn lost. However, there was a bright spot, there was no double dip recession (so at least things aren’t as bad as the 1970’s), and growth in the fourth quarter rose 1%, not bad considering there was a lockdown in November and for most of the second half of December. To put the UK’s performance into context, some countries such as Spain and Italy (also badly hit by a second wave of coronavirus at the end of last year) saw their economies shrink in Q4, so the UK is doing better than them. Growth trends picked up by the ONS, who measure this data for the UK, found that manufacturing and construction bounced back strongly in the final months of Q4, and with the current lockdown less restrictive then the lockdown in March, we expect these sectors to continue to show signs of recovery in the first quarter. This suggests that these two sectors have adapted well to the new Covid restrictions, which should be celebrated. Within the sectoral data, while hospitality and travel have done badly, courier and delivery firms have never had it so good. The impact of Brexit on growth remains unclear, this will become more apparent as we move through Q1. However, stockpiling, as measured in Q4, was less than expected. There was some notable stockpiling of car parts and medicines, according to the ONS, but not much elsewhere, which suggests that imports will likely remain strong in the first quarter of this year. The picture for 2021 is likely to show weakening growth at the start of this year, credit card spending is significantly lower for January this year compared with other years, but this could help boost growth later on as the nation spends their savings once lockdown restrictions are lifted. Overall, the picture from today’s GDP data suggests that the UK economy is not in fine shape, however, some key sectors are doing admirably well, which suggests that the UK is a dynamic economy that can adapt well to external conditions; this should also bode well for Brexit. However, the economy is unlikely to return to strong levels of growth until lockdowns are lifted – we don’t know when that will be – thus expect business investment and service sector activity to remain depressed for some time. 

Why the UK’s economic performance may not be the worst in Europe, after all 

The point about the dynamic and adaptable UK economy are worth noting, since that is what ultimately drives investment into an economy in the long term. Also, the fact that the UK is outpacing parts of Europe in Q4 is a sign that it’s too early to say who has performed the worst during this pandemic. There are many factors which make international comparison difficult. For example, the way that the UK measures health care and educational output are more stringent than some countries on the continent, which makes our figures look worse. Thus, the government should not be forced to change their economic strategy based on headlines saying that the UK is the worst performing economy in the G7, the data isn’t telling us the whole story, yet. This is one reason why the FTSE 100 is rallying even though the GDP data was not, on the surface, good, below the surface there are reasons for optimism. The FTSE 100 is well placed to benefit from the renaissance in the building trade and the boost in delivery companies with online supermarket chain Ocado being a top performer at the end of the week. Although the FTSE 100 was an unloved index last year, and while the US continues to attract the bulk of interest from investors eager to get exposure to risky assets, the UK could outperform European indices throughout this year. 

UK banks: waiting on dividends 

The UK banks release their earnings in the next 2 weeks, with Barclays and NatWest kicking things off from next Wednesday. We expect Barclays to report decent investment banking revenues, however, low interest rates are likely to hamper earnings in the retail banks and could impact NatWest. NatWest’s share price had a fantastic recovery in the second half of last year, although it remains below its pre-Covid peak, thus it could be hard hit if its performance in Q4 misses estimates. Also, it is worth noting if any of the banks reintroduce dividends, after the BOE lifted restrictions at the end of last year. Dividends would be a welcome addition to boost the appeal of banking stocks and could drive interest into this sector in Q1. Barclays and NatWest had mild losses at the end of the week, however, we think that their stock prices could tread water as we await Q4 results at the end of next week.