Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

New data out today has shown the UK economy contracted in November 2020, raising the chances that Britain will fall back into recession sometime soon.

The Office for National Statistics posted a 2.6% fall in gross domestic product (GDP) in November, the first monthly fall since April when the effects of the pandemic began to be felt. With December also impacted by lockdown and a partially cancelled Christmas, an overall contraction in the final quarter of 2020 now looks likely. If growth continues to be negative in the first three months of 2021, the UK will be in recession once again.

Delving into the figures a bit more, the November contraction was driven by the dominant services sector, which fell 3.4% in the month. Accommodation and food services was the worst hit division within the sector, followed by areas such as motor vehicles repairs.

Production was also marginally lower at -0.1% and construction, which has remained open since the early lockdown measures were lifted, posted a gain of 1.9%.

The news is perhaps no surprise but is disappointing, nonetheless. The UK, in common with the other major economies, had been posting a strong recovery in GDP since the first hit from Coronavirus and this November reading puts that recovery in reverse. By October, UK GDP had recovered to sit just 6.1% below its pre-pandemic reading from February, raising hopes that Britain could pull off a ‘V-shaped’ recovery. With the negative reading in November now taking GDP back to 8.9% below the February reading, the recovery looks more likely to be ‘W-shaped’ at best.

The prospects from here depend greatly on the successful rollout of vaccinations. It is unclear exactly how soon the rising number of jabs can translate into a lifting of lockdown restrictions, and economic activity will continue to be hamstrung while lockdown persists.

For investors, the dismal economic news continues to look out of step with the view of markets, which have recovered much more strongly and continue to be optimistic. UK shares opened lower this morning after the GDP data was released - the FTSE 100 falling 0.45% at time of writing - but continue to hang on to the bulk of gains made since a vaccine was confirmed last year. Elsewhere in the world, US shares remain a whisker below their all-time high.

It’s often said that growth in markets will reflect growth in economies over the long term, albeit with periods of divergence along the way. Right now appears to be one of those periods, with equity markets broadly optimistic despite falling economic growth.

If GDP data continues to deteriorate we may see more pessimism creep into the stock market, and there are already some who point to the very high valuations in some areas of the stock market as evidence that we are in the late stages of an equity market bubble. These gloomy predictions may prove right one day, but there are reasons to think GDP growth and market levels can stay disconnected for a time yet.

Stock market indices don’t mirror domestic GDP exactly. The largest UK companies derive much of their earnings from overseas, where growth may be stronger, and this also applies to many medium-sized and even small UK companies as well. The lockdown which has hurt some areas of the economy so badly can be seen in the stock market, of course, but the effect is currently concentrated in just a few sectors. Others have been unaffected and have even seen their prospects improve as economic activity is moved online, or otherwise displaced from one area to another.

The experience of the last year is that markets have been willing to look through bad news on the pandemic - including bad economic news. With a vaccine now in place, that looks set to continue.

Nonetheless, we should expect more volatility from here. It’s a good time for investors to focus on their defensive game, with portfolios kept diverse by region, asset class and investment style, and cash levels maintained to provide a buffer if market levels fall from here.

Glossary

GDP: Gross domestic product is the market value of all officially recognized final goods and services produced within a country in a year, or other given period

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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