UK economy and corporate profits: Refusing to follow forecasts

Since July, there have been over 250 UK corporate earnings reports or trading statements, which we have been tracking for any sign of Brexit-related weakness. Within these corporate filings we can find little evidence, in either outlook statements or in managements’ referendum commentary, to suggest a slowdown in trading is underway.

On the contrary, over 80% of company earnings reports indicate that trading is in-line with earlier expectations. Furthermore, 16% of companies report that trading is ahead of expectations against only 3% reporting that trading has fallen below expectations. In addition, recent data on house prices and manufacturing surveys seem to confirm that fears of a Brexit-induced slowdown in the UK have proved overblown, over the summer at least.

Exhibit 1: Analysis of UK managements’ earnings outlook commentary

Exhibit 2: Uncertainty the key theme of referendum commentary – but few references to actual slowdown

Furthermore, while management commentary on the UK’s referendum often cited heightened risk and uncertainty, Exhibit 2, this perhaps also tells us that executives are struggling to identify specific dangers or opportunities. Only 8% of these reports highlighted any slowing of activity due to the referendum. Perhaps this is understandable as the process is in its infancy, with Article 50 not due to be triggered before the beginning of 2017 and the scale of any UK fiscal stimulus not known before the autumn.

Exhibit 3: Surprise rebound in manufacturing PMI in August

Exhibit 4: Retail sales and house prices remain robust

However, while it may be tempting to sound the all-clear for investors we would instead focus much more on how the recent incoming data – on earnings, manufacturing activity and house prices – have all been much stronger than might have been expected from earlier, more negative, surveys. While we doubt the Bank of England will change tack immediately, we remain of the view that in an environment where inflation expectations are running at over 2.6%, UK gilt yields are at risk of moving sharply higher if the forecast slowdown for 2017 fails to materialise. Such a move could easily take the steam out of the UK’s equity market which once again, as we note here, is trading close to the upper end of its historical valuation range.

Quick conclusions

1. The evidence from management commentary suggests a very limited impact from the UK referendum on corporate profits to date.

2. We believe the rally in UK assets was at least in part driven by expectations of another period of very loose monetary policy; higher than expected UK growth would challenge this thesis.

3. We are now cautious on UK bonds at such low yields and while corporate earnings may be stable, we believe above-average equity valuations place the market at risk from any increase in bond yields.