2 Reasons Why A UK Recession Might Be A Good Thing
By Alex Pritchard
On a recent episode of our new podcast, A Dab Of Investment, I talked about what everyone will agree is a rather scary word: recession.
A couple of weeks ago the Bank of England issued a statement saying that the UK is facing its longest recession since records began. This is predicted to be a long, but shallow, recession, possibly in the region of two years.
This is potentially scary news, based on the fact that in the last recession – the credit crunch in the late 2000s – the market fell 40%. Investment similarly struggled when the tech bubble burst in the early 2000s. This again makes the potential of recession feel scary when it comes to thinking about our financial futures.
But is it really as bad as we are hearing?
What is a recession?
At Applewood Independent, we are still optimistic – there is a major difference between the state of the markets now compared to previous recessions. If you look at the metrics, we are in a far more solid position today.
In technical terms, what exactly is a recession? A recession can only happen when two quarters in a row show negative growth. Two quarters ago, the quarter was negative. Last quarter, however, was positive – even if by a tenth of 1%. So we cannot technically have a recession until the next two quarters come in with negative growth here in the UK.
While market conditions have not been great, they are starting to recover now. Will we have a recession if market conditions continue to defy the economic outlook and continue to improve?
Inflation and interest
The data that the Bank of England is sending suggests that inflation should be peaking somewhere in the range of 10–11%. As interest rates help to combat inflation, they will be rising in response as well. We have just had a ¾ per cent increase in interest rates and we probably have one or two more increases ahead of us.
At the moment, the Bank of England is estimating that inflation will top out at 11%, and then by the end of next year, be down to zero. Interest rates, however, will go up and remain in that higher range.
Now, to repeat what I said in my previous blog and podcast, high interest rates and inflation unfortunately won’t do the housing market any favours – particularly the buy-to-let market, thanks to variable mortgages.
There will probably be a flood of houses onto the market as they go into negative equity – this will drive housing prices down. Together with our inability to afford as much as we can now, the cost of living, plus high interest rates, this is likely to stop us getting the mortgages we want, particularly if we expect the rates of previous years.
1 – A cheap pound and uncertainty actually work for us
The pound is currently very cheap. On top of this, our companies are being oversold based on sentiment rather than fundamental weaknesses (due to the huge waves of uncertainty around current issues like Brexit, inflation, interest rates, and the war in Ukraine). This is good for future value.
If companies were oversold and cheap because of fundamentals, they would be fundamentally cheap. There would likely be no return on investments for a while. However, if the value of a company being lower is driven by uncertainty, then it is more likely that there will be a good chance of recovery.
This makes the UK an attractive market for investors, which should further fuel growth as the current uncertainty dissipates.
2 – Why overseas investors are scrambling for UK fixed interest and equities
The final factor that is going to drive growth in the next 12 months, and is unique here in the UK, is yield. Yield is the value generated from the investment itself, such as interest or dividends.
The UK fixed interest funds we’re working with at the moment are producing around 9% interest. Even though they have fallen in value, a cheap fund making 9% in fixed interest is really attractive. The last time fixed interest was producing an 8–10% yield was at the end of the credit crunch. Those funds produced 10% per annum for about three years, and they doubled in value as well. So from here onwards, the UK fixed interest looks pretty good.
That said, UK equities look even better. The big dividend producers are looking at dividends from anywhere between 6–12% in a year; and there are a lot of UK equity income funds that are quoting dividends of at least 6–10%. Yes, if you held them until now, you’ve seen a capital loss this year, but that capital loss hasn’t been eye-watering.
If 10% dividends are going to kick in and the pound is cheap, overseas investors are going to want them. The return might not be strong – which is to say the share price might not move much in the year – but if you can own a share that’s going to give you a 10% dividend, you definitely want a piece of the action.
Final thoughts – the light at the end of the tunnel
So, let’s return to the beginning of this post and the big, scary word “recession”. I am not sure that there will be much negative impact of a recession in the UK, compared to the tech bubble bursting or the credit crunch. The UK is so cheap right now that there is not much further it could fall. On top of this, there is so much value to be had in the UK market at the moment.
This value means that – to me – it feels more like the end of a recession than the start of one. Everything is cheap, not expensive. People are not riding on a year of unsustainable gains, we are actually riding on losses at present.
It has to be said that as independent financial advisers, we specialise in investment, not economic factors. However, we feel that the UK is currently looking good if a recession does in fact happen. While other economies, such as the US, might suffer, if the world is turning to yield over return when it comes to choosing investments, then the UK is well placed to benefit.
For useful insights as to the state of the market and risks of recession – including more detail on why the UK markets can only grow from this point onwards – why not listen to our new podcast A Dab Of Investment?
And if you’d welcome our input, expertise and experience, please get in touch by emailing me at alex@applewoodindependent.co.uk.
The views expressed in this article are those of the author and do not constitute financial advice. Applewood Independent Ltd is authorised and regulated by the Financial Conduct Authority. For financial advice designed for you and your specific circumstances, please contact the author using the contact details provided in this article or, alternatively, contact the Applewood Independent Ltd office on 01270 626555.
The value of your investment can go down as well as up, and you may not get back the full amount invested.
Past performance is not a guide to future performance.
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