The UK entered a technical recession last month. While there is still some question over how severe or prolonged this recession will prove to be, growth is forecast to be at a miserly 0.8% for 2024 as a whole, hindered by persistently low productivity levels.
This lacklustre outlook will be little cause for cheer for investors in the UK and is unlikely to bring greater market stability. However, a UK recession is not necessarily the disastrous scenario some fear. Indeed, there are some factors that should bring comfort to investors.
First, while the 0.3% drop in GDP that led to this might not be welcome news, it is not as steep as feared, and there is every indication this recession will be relatively mild.
With confirmation the economy is contracting, the Bank of England will feel additional pressure to start cutting rates
And given fears of a recession has dominated the outlook for so long, there is a broad consensus that this scenario has already been priced into markets, going some way to neutralising its potential negative impact on returns.
There are also implications for the future trajectory of interest rates. It is almost universally held that the current cycle of fiscal tightening has come to an end, with many now watching for the first cut in rates. With confirmation the economy is contracting, the Bank of England will feel additional pressure to start that process.
Of course, the timing of the first cut in interest rates in the UK is difficult to predict. Many commentators now view a cut soon as much more likely than previously thought, but as economic data continues to give mixed messages, it is still not a given.
High-quality companies are better equipped to weather the storm and even strengthen their market position
The Bank of England governor recently maintained he anticipates a rate cut this year but would not commit to when that might be and by how much. He also pointed to signs the UK is already showing the buds of recovery, evidenced by increased consumer spend in January. To some extent, this alleviates the immediate pressure on the Bank of England to start reducing rates.
Despite the reasons for being cautiously optimistic about the prospects for the UK economy and the potential for the current recession having less impact than has previously been the case, any GDP contraction should not be taken lightly. Nonetheless, it is also important not to be overly alarmed.
Investors should have a meaningful time horizon over which to measure their portfolios – between five and 10 years – and should avoid the temptation to act rashly in light of near-term events. Healthy compound returns are historically achieved by remaining invested over a long-term period, regardless of bumps in the road along the way.
While the 0.3% drop in GDP that led to this might not be welcome news, it is not as steep as feared
There are a number of ways in which investors can make this long-term journey less fretful. A first step is to back best-of-breed fund managers that have demonstrated their ability to consistently deliver returns in line with their stated objectives, over an appropriate time period and by following a robust investment process.
Secondly, diversification can help ensure exposure to one asset class is limited. History has shown it is almost impossible to say with certainty which asset class will be the best performer from one year to the next, so diversified portfolios have the potential to provide value combined with lower volatility over the long term.
Third, the old adage that ‘quality will out’ rings true when it comes to investment. While all businesses can be hit in a recession, high-quality companies are better equipped to weather the storm and even strengthen their market position relative to their peers during times of economic weakness.
Matthew Belcher is investment manager at Square Mile Investment Consulting and Research
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