Thus far this year, global stock markets have declined. The all-country MSCI ACWI Index is down 5.91% year-to-date February 18. International markets excluding the US also are down but by less. The international MSCI ACWI ex US Index is off 1.87% year-to-date. Within Europe the Eurozone MSCI EMU Index is also down, declining 4.36% year-to-date. It is a time to look for markets that continue to attract investors’ attention, with economies that are emerging with strength from the late-2021 slowdown. This note focuses on one such economy and market, the United Kingdom. The MSCI United Kingdom Index is up 3.27% year-to-date. Over the past 12 months ending February 18, that index is up 15.61%, some three times the 5.45% gain over the past 12 months for the all-country MSCI ACWI Index.
The latest data available on the UK economy is strongly positive, with one exception, the intensifying cost pressures. The just-released flash UK PMI data for February indicate that the private sector is accelerating at the fastest pace since June 2021, following the disruptions caused by the fast-spreading Omicron variant of Covid around yearend. It is impressive that private sector output has increased for 12 months in a row. The service sector rebounded to an eight-month high with a strong recovery in consumer spending on travel, leisure, and entertainment. Bear in mind that services account for over 81% of the output of the UK’s economy as measured by GDP. While the flash PMI for manufacturing remained at the January level, that masked growth in manufacturing output that was the strongest since last July, a surge in incoming new orders, and strong business optimism. Output is now back to its pre-Covid level. This recovery follows one of the steepest output declines among advanced economies, over 9% in 2020.
The negative news on inflation in the PMI report is a reason for caution. Input prices are surging at the second highest pace since the index began in 1998. The CPI averaged 4.9% in the fourth quarter of 2021. A peak CPI rate of some 7.5% looks likely to be reached in April and then to slowly moderate. For the year 2022, the average CPI could approach 6%. The deteriorating situation with respect to Ukraine may well add to inflationary pressures. This cost outlook suggests consumers will be faced with lower real incomes. Another headwind will likely come from a more aggressive monetary policy, with rising interest rates, as the bank of England seeks to counter the high inflation. Fiscal policy is also expected to become tighter.
Despite these concerns, UK businesses are optimistic, as the PMI report notes. Their investment intentions appear to be becoming more robust, reflecting in part strong financial positions for most, including large excess cash positions and a tax incentive to use that cash for capital spending. We have been among those that were concerned that the UK’s exit from the European Union and its single market (Brexit) would harm the UK economy and have a negative effect on business investment. It is still too early to quantify the full effects of Brexit and separate them from the effects of the pandemic. Indeed, the trade relations between the UK and the EU remain unresolved, and difficult negotiations continue. We remain convinced that the uncertainty in the lengthy lead-up to Brexit and the continuing uncertainty due to many important unresolved issues have already had a negative effect on investment as well as raising costs and reducing GDP. The fact that Brexit has not been in the front pages lately may suggest to some that it is becoming less a concern. However, the costs to business are evident. We will continue to monitor developments in the Brexit negotiations and the implications for our UK positions in our International and Global Equity ETF Portfolios.
William H. Witherell, Ph.D.
Chief Global Economist
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Sources: Financial Times, Oxford Economics, Goldman Sachs Research, HIS Markit, ETF.com
