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Does The Latest Economic Data Put A Cloud Over Unilever plc And Lloyds Banking Group PLC?

Britain technically managed to avoid a double-dip recession in 2012, but it’s having less success finding a path to sustainable economic growth. In recent months we’ve heard negative economic news concerning Russia — now the spotlight is turning on the Eurozone and Britain itself. That has implications for certain FTSE 100 stocks.

When Europe sneezes, Britain catches a cold

An important bit of news this week from the Eurozone was that the single currency block has officially hit a period of deflation. Prices actually fell in December — in large part due to falling oil prices. The Eurozone economy is now looking decidedly weak. The problem for Britons is that more than 50% of the UK’s total trade (5%-6% of GDP) is done with the European Union.

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It’s no surprise then that when Europe falls into difficulty, cracks in the British economy also start to appear. It’s heightened by the fact that wage increases in Britain have only just started to move faster than inflation. Analysts estimate that it’ll take until 2019 before real wages return to levels last seen in 2007.

It should come as no surprise then that the most exposed sector in the British economy — the services sector (accounting for around 80% of GDP) — has fallen back. The latest data by Markit/CIPS show the UK Services PMI fell to 55.8 in December. The City was expecting a reading of 58.5. It’s the weakest pace for 19 months.

The not-so-great news also coincided with disappointing figures for manufacturing and construction in December. Economists say it all points to an economy growing at around 0.5% in the fourth quarter of 2014.

Unilever in the firing line

It’s a simple fact that when consumers have money, they spend a portion of it on food, clothing and household goods. Simply put, you can bet that when the economy was does well, Unilever (LSE: ULVR) (NYSE: UL.US) will do well. For instance in 2013, when activity started to pick-up, the company reported a net profit of £4.4 billion for 2013, up 9% on 2012. It seems the economy now though could be turning in the wrong direction. In particular, recently we’ve seen that consumers are tight for cash, and some are choosing the cheapest option around. Not only is Unilever skewed towards attracting the ‘middle-income’ British shopper, but it’s also exposed to levels of disposable income among consumers, and the economy more generally — both of which appear to be sluggish.

The latest news on wages is an encouraging sign for Unilever but that latest figures on the economy are not. With a dividend yield of almost 4% and a cover of nearly 2, the consumer goods company is still a reasonable long-term play in my view.

What about Lloyds Banking Group?

Here’s my foolish logic. We’ve just learned that the services sector isn’t growing quite as fast as we would like it to grow. We also know that Britain’s many big banks and investment houses make up a significant portion of the services sector. We know too that business from the Eurozone is likely to be quite damp over the next 12 months. It hardly seems probable, then, that the Bank of England will start lifting interest rates early this year. In fact this latest data could push an interest rate rise out until at least the second half of 2015.

So what?

Well if rates stay low this year, the net interest margins of banks like Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US), Barclays and the Royal Bank of Scotland are likely to be stifled — Lloyds in particular because it’s furthest behind, though not by much. Policy makers could also run the risk of creating a housing bubble (a bubble that will ultimately burst) if rates stay at record lows for a longer period of time. Lloyds Banking Group funds around a third of all British lending, so that would only add to the risks facing Lloyds’ balance sheet.

Reaction time

If your move to some of the more growth-exposed stocks in the FTSE 100 was influenced by a strong optimism about the economy in 2015, it might be the time to consider more ‘defensive’ stocks instead.

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David Taylor has no position in any shares mentioned. The Motley Fool UK owns shares of Unilever. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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