Double-dip doubts
31/01/2012
- Muted response to UK recession fears
- Downside risks and upside opportunities remain
In contrast to the positive US numbers, Wednesday saw the release of preliminary figures from the Office for National Statistics (ONS) confirming that the UK economy shrank by 0.2% in the last quarter of 2011 and grew by just 0.9% over the year as a whole. The quarterly fall in GDP was the first since the last three months of 2010, when freezing weather was blamed for a 0.5% drop. This time it was the fault of the warm weather as people turned down the heating, causing a 4.1% drop in electricity and gas production. The figure was not unexpected but worse than had been feared, as most economists had forecast a 0.1% fall in activity. The previous day, the International Monetary Fund (IMF) had cut its growth forecast for the UK economy in 2012 to 0.6% from 1.6%.
That the news came as little surprise was reflected in the phlegmatic response of the markets, which were equally unfazed by the inevitable debate over whether the UK is now halfway towards a double-dip recession, technically defined as two successive quarters of negative growth. The FTSE 100 Index ended the week virtually unmoved, having risen 0.09% but 2.9% up for the year to date. Graeme Leach, the chief economist at the Institute of Directors, said:
"The tightrope walk between recession and recovery continues. We've taken one step towards a
double-dip recession, and it's now probably 50-50 as to whether we'll take the second. It's important to stress that the 0.2% fall in GDP is not large and could be reversed as QE2 works through the economy. But even if output does increase in Q1, we'll continue to experience a feel-bad jobless recovery for some time yet. Indeed, the combination of falling output and [Wednesday's] MPC minutes suggest QE2 could be further expanded in February."
Whilst the market has discounted a lot of poor economic news, a further escalation of the crisis, a disorderly default and exit of the euro by Greece would clearly threaten the world economy and global stockmarkets. However, for the first time some are beginning to think the previously unthinkable and reflect on the outcome for markets if economic news does slowly begin to look better and the eurozone avoids imploding. A double-dip recession would be the first for 37 years but what does it mean for investors? In three of the last five recessionary periods the UK stock market has actually risen and the ratio is similar for US recessions and market returns. That said, America, in the shape of the National Bureau of Economic Research, has a different definition of recession: "a period of falling economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale retail sales".
Whatever the definition, for those with the necessary medium-term time horizon, bad news for the economy can signal a good time to buy into the markets. Albeit with the usual caveats, history shows that the stock market has a knack for discounting future events and will turn up well before an economical recovery is evident. Indeed it will often pick up when the outlook is at its worst, typically rising 6 to 12 months before a rise in GDP.
Analysis by Fidelity shows that an investment made in the FTSE All-Share Index at the end of the last recession - the second quarter of 2009 - would have made 56% in the following two years. The same two-year figures for the 1990s' and 1980s' recessions would have been 18% and 30% respectively.
The potential long-term opportunity presented by current equity markets was suggested in analysis by J.P. Morgan, which last week showed that UK stocks are the cheapest in the world compared to their historic averages since 1987. At 9.6 times next year's earnings (the p/e ratio), shares are 31% below the historic average. This compares with European shares at 9.9 times, 30% below their long-term average; and 12.3 times for US stocks, which is 21% lower. However, the advice for investors remains the same: shares need to be viewed as long-term investments, not quick-win solutions, and a well-diversified portfolio will help cushion the impact of the likely continued volatility in markets.
