Paul Danis, Head of Asset Allocation, considers the impact of a UK recession on investment portfolios and the outlook for different asset classes going forward.
The economic impact of lockdown has taken its toll, with the UK now being technically in recession.
A recession is generally considered to be two quarters of declining GDP. However, while the decline in UK GDP
has been very steep (22.1% peak to trough), this will likely be a recession rather than depression, given it appears short-lived.
Why is the UK in recession?
Recessions can happen for various reasons, and they are typically associated with rising unemployment and falling household spending.
Over the past century, there have been a range of causes of UK recessions, which are generally understood to be shallow or short, and depressions, which are deeper and longer lasting. For example, the deep deflation following the end of WW1 resulted in the depression of the early 1920s.
The 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 recession of the early 1980s stemmed from high inflation and interest rates. The early 1990s recession was sparked by high interest rates, falling house prices, an overvalued exchange rate and spill overs from the US savings and loan crisis. Finally, the recession of the Global Financial Crisis was due to high interest rates, alongside excesses and imbalances in the banking and the real estate sectors.
By contrast, the recession of 2020 is unique as it stems from efforts to suppress the spread of COVID-19.
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 reason the UK economy has been particularly hard hit is because it is a particularly service-oriented economy, which is the sector the COVID-19 crisis has impacted most.
How has the recession impacted equity markets?
The deepest declines in global equity markets tend to be associated with lengthy recessions. Examples include the long-lasting recession of the early 1970s and the recession associated with the Global Financial Crisis, which saw global equity markets suffer deep declines.
The 2020 recession has seen global equities drop with unprecedented speed. The declines reflect the magnitude of the decline in economic activity and the uncertainty around the virus. However, 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. These companies’ earnings have held up relatively well due to the nature of the recession and have benefited from the very low interest rate backdrop. By contrast, the UK, with high exposure to out-of-favour financial and energy sectors and low exposure to tech, has underperformed.
What’s the outlook for global equities from here?
The market has rebounded significantly since the dark days of March. But there are potential risks to performance. While the virus is the biggest threat, ongoing US/China geopolitical tensions are also a concern.
Nonetheless, we remain optimistic toward equities. Central banks are signalling a ‘lower for longer’ rates environment. This has pushed yields available on assets that compete with equities and discount rates used to finance business activity to extremely low levels. Against this backdrop, the appeal of equities has grown, and we expect them to be the top-performing asset class over the coming twelve months.
Paul Danis, Head of Asset Allocation
Paul Danis is Head of Asset Allocation at Brewin Dolphin. Paul began his career in 1998 trading interest rate futures and options in the pits of the Montreal Exchange. In 2001 he moved into research, and has worked as a strategist on the sellside (Lehman Brothers/Nomura), the buyside (Credit Suisse) as well as in independent research (BCA Research). Paul graduated from McGill University and is a CFA charterholder.
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