The UK economy is fragile. That was the main message from experts this morning as domestic GDP figures flatlined in July.
It follows a 0.4% month-on-month rise in June and means that economic growth stood at just 0.2% for the three months to the end of July.
Manufacturing production fell sharply and the trade deficit was worse than expected, with multiple market commentators noting that the figures showed just how “fragile” the UK economy truly is.
Scott Gardner, investment strategist at Nutmeg, said: “Few positives can be found from this latest batch of GDP data.”
On Wednesday this week, Rathbones multi-asset fund manager David Coombs, warned there was a “super high” risk of recession in the coming months, a notion that these figures will have done little to dissuade.
What’s causing it?
There are myriad domestic factors that experts pointed to, ranging from Labour’s National Insurance changes in April finally feeding through to the economy to businesses remaining wary as speculation on how the government will approach its financial woes in November’s Budget ramps up.
Any fiscal tightening by the government to address the ‘black hole’ in the country’s finances will likely be prohibitive to growth.
AJ Bell head of financial analysis Danni Hewson noted that many businesses that had already delayed investment and job creation due to the impact of last year’s Budget on labour costs (mainly through its rise in National Insurance contributions), “have kept their fingers on the pause button as they consider what taxes might go up in order to fill the hole in the public finances”.
Although the retail sector held up well in July, there are concerns over consumer confidence too, which could fall as we approach the chancellor’s policy announcements.
Then there are external factors, such as US president Donald Trump’s tariffs, which are impacting global trade, leaving few countries unscathed.
The issue also impacts the Bank of England. While the central bank expects inflation to lift in the coming months to around 4%, it has made clear that its focus at present is on improving the economy.
This implies interest rate cuts, but this will be thrown into doubt if price rises continue or pick up more than currently forecast.
What should investors do?
Coombs said there was little reason to own a small or mid-cap fund in the short term, something I agree with. Although they are already cheap compared with larger companies, these stocks are overly reliant on the domestic economy (in the main), and therefore are hit harder than their large-cap peers when the economy wobbles.
While I am invested in a UK smaller companies fund myself for the long term, right now it appears they are under pressure.
There is also a case to be made to avoid active managers. A large swathe of active managers have underperformed over the past year as they typically hunt for new ideas further down the market capitalisation spectrum, a topic Patrick Sanders covered earlier today.
In my own portfolios, I have leaned into the Vanguard LifeStrategy 100% Equity fund, a passive fund of funds that is actively tilted. It has an historic and entrenched overweight to the UK but does so through a large-cap tracker, meaning it is not as exposed to those stocks that will be hit harder by a potential domestic recession.
But there are no guarantees. The Bank of England and the chancellor could pull a proverbial rabbit out of a hat and in 12 months the UK could be flourishing again. Or we could be in the midst of a recession with endless problems to solve.
With such a wide range of outcomes, caution is advised. While there may be big gains to be made in certain areas, diversification will remain key.