Cooling Britannia

There’s no end in sight to the uncertainty surrounding Brexit, but we can provide some useful insights to cut through the fog and help clients navigate these troubled waters by considering the broader state of the nation’s economy.

We have a small, open economy, which may sound a little strange, if you know that the UK has the world’s fifth-largest economy by gross domestic product. However, it isn’t large enough to influence global asset prices, interest rates or the pace of global growth in any meaningful way. Last year, the UK economy accounted for 2% of global output and since 2008, the UK has accounted for just 1% of new economic output.

The UK stock market is not the UK economy

At first glance, that’s nothing to cheer about. But there is good news for your clients’ investments – the UK stock market is definitely not the UK economy. Publicly listed UK companies as a whole only get about 30% of their revenues from the UK, with the vast majority of earnings sourced from overseas. This means that our stock market is exposed to faster-growing economies which should boost revenue growth for UK equities.

Meanwhile, sterling has already fallen so much that it is now significantly undervalued against other major currencies and pessimism has been priced in. You even may start to see UK equities coming back in favour with value-hunting global investors, regardless of the Brexit outcome.

However, we may be a small economy, but we have some big problems. It took the UK a lot longer than most economies to recover from the 2008 global financial crisis, given very weak growth in output per capita. It has averaged just 1.2% per year — a serious drop compared with the 2.5% per year it averaged in the previous 25 years.

Brexit is only part of the problem

The UK isn’t the only country to suffer slowing output per capita, but the fall in living standards since 2008 has been particularly severe. We are undergoing the longest slump in the standard of living for at least 150 years and have the poorest rate of social mobility of any major advanced economy.

Brexit has made our future uncertain and business investment has plateaued in the UK, while it’s been accelerating across the rest of the world. Although households have been consuming more, many have done so by reducing saving. The uncertainty is taking its toll and could continue to weigh on capital growth for years to come.

What about our outlook over the next 10 to 15 years? Rathbones’ own forecast for the UK puts the pace of economic growth at about 1.5% per year. That may sound decent, but it’s actually weak compared with the past and to the rest of the world. So why is our future one of relatively weak growth?

There are a few reasons, many of which are common across major developed economies, including an ageing workforce and slower investment in capital (factories, computers, etc.). Our unique problem is the marked slowdown in the rate at which foreign companies and governments are taking ownership stakes in domestic assets. That is worrying because modern economic growth relies on this kind of inward investment for technological transfer, or learning from others and improving on it. Firms that receive investment from overseas are almost twice as productive as firms without any such link, and it’s that potential slowdown in productivity that we are worried about.

There is a way out

Is there a solution? Yes is our view — investment in research and development (R&D), across both public and private sectors. R&D is vital to kick-starting new technologies and increasing growth, but we have fallen behind other major economies in the amount we spend on R&D relative to the size of the economy. Beyond the short-term risk to trade from Brexit, the more interesting longer-term question is whether further EU harmonisation would divert trade away from the UK if the country is not part of the club. The UK may even experience a positive shift if it can successfully invest in R&D and successfully negotiate new treaties with higher-growth nations.