The UK economy has gone into recession. What does this mean?
19 August 2020
Following news last week that the UK is officially in a recession, we spoke to Steven Banham, investment manager at Brewin Dolphin’s Birmingham office and patron of Made in the Midlands, about what this really means for businesses.
A recession is generally considered to be two quarters of declining GDP. Recessions are treated as finite – in or out. But in reality, they can be deep or shallow, and they can be short or long. They are typically associated with rising unemployment and falling household spending.
Why is it happening?
Recessions can happen for a number of different reasons. Over the past century, there have been a variety of causes of UK recessions (generally understood to be shallow or short) and depressions (deeper and longer lasting). For example, the deep deflation following the end of WW1 resulted in the depression of the early 1920s. The global Great Depression of the early 1930s saw a sharp collapse in UK exports. The early 1970s recessions were driven by an oil shock and industrial disputes. Meanwhile, the early 1980s recession stemmed from high inflation and the economic pain from high interest rates. The early 1990s recession was sparked by high interest rates, falling house prices, an overvalued exchange rate and the spill overs from the US savings and loan crisis. Finally, recession of the global financial crisis was due to high interest rates, as well as excesses and imbalances in the banking and the real estate sectors.
The recession from the first half of 2020 was unique in the sense that it stemmed from efforts to suppress the spread of COVID-19. Although the decline in UK GDP has been very steep (22.1% peak to trough), this will likely go down as a recession rather than depression given it looks like it will be short-lived. But although the economy has rebounded strongly since May, the UK is not out of the woods yet. The risk is that the recovery will slow once the furlough scheme ends in October, which is estimated to lead to more permanent job losses. So, while the economy has recouped a third of the fall in GDP in just two months, it may take 12-18 months to get back to pre-Covid-19 levels. If headwinds materialise later in the year, we think the Bank of England will expand its asset purchase program and further stimulus maybe announced by the Chancellor.
How has the UK economy performed compared to other countries?
Of the major European countries, only Spain has suffered a sharper economic contraction in the first half of this year. The UK economy has been particularly hard hit given it is a very service-oriented economy, which is the sector the COVID crisis has impacted most.
How has the recession impacted equity markets?
The deepest declines in global equity markets tend to be associated with long lasting recessions. Examples include the long-lasting recession of the early 1970s and the recession associated with global financial crisis, which saw global equity markets suffer deep, long lasting declines.
This recession, global equities dropped with unprecedented speed. The declines reflected both the magnitude of the decline in economic activity and the uncertainty around the virus. The good news is that the equity market declines, although painful, were short-lived, lasting about a month. After quickly pricing in the economic pain, markets then started to price-in a recovery, with gains supported by hyper accommodative monetary policy.
Some regions have fared better than others as equity markets have recovered. The US has led, given it has high weightings in the tech and internet growth-oriented names whose earnings have held up relatively well due to the nature of the recession, and have benefited out proportionally from the very low interest rate backdrop. The UK, with its high exposure to the out of favour financial and energy sectors and low exposure to tech, has underperformed.
What’s the outlook for global equities from here?
It’s worth noting that the market has rebounded significantly since the dark days of March. That improved sentiment means there is less upside than there was.
And it’s definitely worth being aware of the risks. The virus is the biggest, and US/China geopolitical tensions are also worrying. Nonetheless, we remain optimistic. Central banks are signalling a “lower for longer” rates environment. This has pushed both yields available on assets that compete with equities and discount rates used to reduce the present value of future corporate cash flows to extremely low levels. Against this backdrop, the attraction for equities has grown.
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