Last week the ONS estimated that the UK economy had grown by just 0.2% during the first quarter of the year. Following on from three quarters of resilient output growth, this naturally poses the question whether the sugar rush of stimulus is beginning to fade. The slowdown resulted from a significant widening in the UK’s trade deficit alongside a slowdown in household consumption: Figure 1. The headwind to output growth from the widening trade deficit will - in our view – weaken in H2 2017 as the recent stabilisation in Sterling combines with the lagged impact of home-biased consumption and heightened export competiveness. A more detailed evaluation on the likelihood of a ‘J-curve’ response in the UK’s current account will be the subject of a future post. For this entry we confine ourselves to looking at the prospects for UK consumer spending for the rest of the year.
The moderation in UK output growth during Q1 was led by a slowdown in the wholesale and retail sub-sector: Figure 2. This is a sector worth more than 10% of the UK economy and it contracted by almost 1% QoQ during the first three months of the year. UK consumers exhibited signs of having overstretched themselves in H2 2016 as the savings ratio fell to an all-time low of 3.3% and unsecured consumer credit grew at 10% YoY. Retail sales volumes grew by just 2.1% YoY in Q1 having averaged 4.9% during 2016.
The broader basket of UK economic data has begun to underperform expectations in recent months, having rebounded strongly since the EU referendum: Figure 3. By contrast consumer confidence has stabilised in recent months and remains above its long term average – Figure 4. For consumer discretionary equities it is the outlook for UK consumer confidence that is most material for returns. Historically equities in this sector have the highest correlation to the confidence indicator: +0.83 over the last 10 years.
The Outlook for Confidence
Looking ahead to the rest of the year the latest BoE Agents Survey indicates robust and recovering employment and investment intentions: Figures 5 & 6. This tallies with leading indicators from recruiters as well as the likely spill-over provided by accelerating global growth that saw the April IMF estimate for global growth upgraded to 3.5% - an acceleration from the 3.1% achieved in 2016.
The other major driver for the consumer will be credit conditions. These remain supportive with mortgage and unsecured loan interest rates continuing their steady fall: Figure 7. Furthermore the pressure on real wages from higher inflation is set to be a transitory affair, considering the pricing pressures that resulted from GBP devaluation and the increase in energy costs have peaked: Figure 8.
There are undoubtedly collective challenges posed by Article 50 uncertainty, additional payroll burdens (National Living Wage, pensions auto enrolment and the apprenticeship levy) and the challenge to household budgets from a further round of welfare cuts and the 4.0% 2017/18 increase in council tax bills. However the basis for our more bullish outlook than market consensus is captured in Figure 9 – this is our own measure of the policy stimulus delivered since the Referendum. It captures the impact of GBP weakness, the BoE’s stimulus package and the softening of the pace of austerity. Stimulus is now at its highest level since late 2013. Figure 10 shows the attractive valuation of UK consumer discretionary stocks versus their European and US counterparts - with the leading PE of consumer stocks at the 47th percentile, compared with 60 in Europe and 72 in the US.
To finish, in Figure 11 we plot the relationship between Consumer Discretionary stocks and their post-2009 correlation to Consumer Confidence. There is an intense grouping between +0.6 and +0.9 with many of those names that sit outside this zone facing intense firm specific issues.
To conclude we remain upbeat on the outlook for the UK consumer with headwinds from a near term spike in inflation offset by significant policy stimulus and a recent pick-up in global growth. With growth expected to accelerate in Q2 and near term indicators suggesting robust employment and investment intentions we are attracted on deep value grounds to consumer discretionary stocks buffeted by overdone concerns on an inflation-led contraction in consumer spending.