First quarter GDP numbers – our house view

Early estimates for first quarter GDP from the US and UK showed a slowdown that fell further than forecasts. On deeper inspection the US figures are less concerning, with signs of increased business investment and transitory/low-quality detracting factors. In the UK we remain concerned that there is not a clear replacement for the unsustainable consumption growth that drove GDP in the second half of 2016.

The headline US and UK numbers

The first estimates for Q1 GDP growth have been released in the US and UK, with both falling somewhat short of expectations. The UK economy grew 0.3% quarter on quarter, which was down from 0.7% in the final quarter of 2016 and below estimates for 0.4%. On a year-over-year basis, the economy expanded 2.1% (up from 1.9% in Q4, below forecasts for 2.2%).

Over in the US, which by convention releases data annualised, Q1 GDP increased 0.7% compared to Q4 in 2016, sharply down from the 2.1% in the previous quarter, and disappointing forecasts of 1.0%. Although these figures are seasonally adjusted, first quarter numbers have appeared consistently low over the last few years, leading to suggestions that there are flaws in the calculations (‘residual seasonality’). However, the scale of this movement suggests there is more to the fall than a statistical anomaly.

It should also be remembered that these numbers are the first estimates, based on early reports of output levels, which are subject to revision – so the absolute numbers should be taken with a pinch of salt.

Key drivers of the changes

Early UK releases are typically light in detail but a slowdown in services, which constitutes the bulk of GDP in the UK, is clearly in evidence – growing just 0.3% quarter on quarter from 0.8% previously. Distribution, hotels and restaurants actually contracted (by-0.5% quarter on quarter from 2.0% expansion previously), whilst transport, storage and communications shrank -0.2% quarter on quarter from 0.8%. Construction and production were also somewhat weaker.

Putting residual seasonality to one side, there were a number of drags in the US figures – most notably a significant slowdown in personal consumption (0.3% from 3.5% quarter on quarter annualised) and a run-down in inventories which were particularly strong in the previous period. Reduced government spending was also a negative contributor. There were, however, encouraging signs, particularly from non-residential fixed investment which increased 1.1% from 0.1% in Q4.

Our view

There are few real surprises in these latest releases, and it’s important not to get too bogged down in the noise – particularly from these early estimates. An initial reading, though, suggests that there may be some underlying strength in the US economy despite the softer numbers, whilst the slowdown in the UK is potentially more significant. In particular, we remain concerned that consumption, which was a key driver of growth in the second half of 2016 may be ebbing, and we look to a resumption of industrial and business activity to sustain further growth.

With that in mind, the increase in US fixed investment spending is a positive development, and reduced inventory investment is not a bad sign. Rebuilding stock in Q4 following an earlier fallow period is consistent with economic recovery, but further increases could signal stock is being produced but not sold. Overall, we are currently quite relaxed on the US reading, and the weak figure could well be transitory.

Conversely, the UK slowdown follows a period in the previous two quarters where business investment remained poor, and the consumer was doing most of the leg work. However, with real wages flat and consumers opting to run down their savings and load up their credit cards, the spending spree never looked sustainable, and more recent retail sales figures have disappointed as retail prices have risen.

Metrics related to consumption will be particularly important over the next few months, with sustainable economic growth likely to need real wage growth. In the UK, as the consumer becomes ever more subdued, fresh business investment growth is also going to be important.

How have the numbers affected our investment strategy?

Our investment strategy remains neutral on the UK, in recognition of some of the challenges from unsustainable consumption in the second half of 2016, and the domestic economy is unlikely to prosper without other growth factors improving. However, with the majority of large-cap UK firms deriving revenue from overseas, and signs of strength in the global economy, there are still opportunities in the UK equity market. Conversely, we are cautious on US equity investment – although we are less concerned about economic growth, valuations are unappealing. Our US exposure is focused on high-quality names that justify a premium valuation.