Inconceivable

“You keep using that word. I do not think it means what you think it means.” So uttered Inigo Montoya to Vizzini in the 1987 comedy adventure classic, The Princess Bride. Whilst undoubtedly showing our age at this point, we imagine (hope) there have been similar conversations recently for a great many naysayers on the British economy.

Why would that be the case? Well, it all comes down to material recent adjustments to the UK’s GDP performance over the last few years by the Office for National Statistics (ONS). Whilst this may sound like an arcane, theoretical issue, we believe it is of critical importance when it comes to debating the prevailing narratives relating to the much-maligned UK.

In our view, the predominant narrative, ever since the 2016 Brexit vote, has been one of impending disaster for the UK economy, given it was such a huge mistake to sever ties to our major trading partner in the way that we did. This narrative has been compounded recently with frequent reminders that the UK economy has not yet recovered to pre-pandemic levels, and sits at the bottom of the G7 consequently. Indeed, the ever-cheerful BBC, in January this year, helpfully joined the dots by proclaiming ‘The UK is the only major rich economy that remains smaller – poorer – than prior to the pandemic and Brexit may be a factor.’

To be clear, this note is not intended to offer a view on the merit or otherwise of Brexit, or our policy responses during the pandemic, we are where we are after all. However, we have argued on numerous occasions that the evidence on the ground in the UK has been nowhere near as pessimistic as the ‘consensus’ opinion, and these new datapoints are extremely important in that regard.

The chart above shows the effects of the ONS adjustments on the size of the UK economy over 2020 and 2021. Taken together, not only had the UK economy regained its pre-pandemic size by the end of 2021, but at the end of that year the economy was nearly 2% bigger than previously reported.

We will spare you the details of the data adjustments made, the ONS explaining them primarily as a result of ‘richer data from our annual surveys and administrative data.’ Specifically, the results included dramatic upgrades in parts of the services sector, which makes up nearly 80% of UK GDP. The ONS now thinks the services sector grew by 10.9% in 2021 compared to the previous estimate of just 7%.

The implications of these adjustments for the UK’s performance relative to other economies are profound. Not only is the economy larger than pre-COVID, but by the end of 2021, the UK’s recovery only trailed those of the US and Canada in the G7, and was significantly ahead of Germany, Europe’s largest economy. Furthermore, as the table below shows, we have grown significantly faster than most major European countries over the period since 2016, the year we voted to leave the EU.

A cursory glance at the above numbers does not suggest the degree of economic damage long feared by Brexit opponents. Of course, we will never know the counterfactual, and it is entirely possible that UK economic growth would have been even better had we not voted to leave, but our point is simply that the prevailing narrative does not necessarily align with the facts, and that narrative has been hugely influential in the attitude of investors towards UK equities.

Regular readers will recognize our frustrations with the extreme pessimism we observe towards all things UK equity related, in no small part driven by the dominant narrative of the poor economic performance of the UK. As we have previously highlighted, the consequence has been persistent outflows from UK equities over many years and near record valuation discounts for UK equities relative to international peers.

We remain firmly convinced that, ultimately, value will be realized and that much of the pessimism towards the UK is cyclical in nature rather than structural. That is not to say that the UK economy is in rude health by any means. We still have many serious challenges, from uncomfortably high inflation to lowish growth, and a whole host more issues besides. Then again, last time we looked, so have many other countries.

On that last point, the next time you hear another prevailing narrative – that the UK’s high inflation rates are an outlier – the chart below might be useful for context. Not necessarily comforting of course, but another example, we think, of the facts not entirely supporting the popular wisdom.

We will end with a chart of the FTSE All-Share Index relative to the STOXX Europe 600 index, over the last year, in US Dollar terms. Early days certainly, but just maybe, Mr. Market is starting to acknowledge things are not so bad in the UK after all. What a narrative that could be.