Stock market and economic commentary - January 2021

“The way I see it, if you want the rainbow, you’ve got to put up with the rain.” Dolly Parton, American singer and songwriter

Just over 12 months ago the World Health Organisation issued a warning that the Chinese authorities had alerted it to an outbreak of “pneumonia of unknown cause” in Wuhan, until then a little-known region in the Hubei Province in the very heart of China.

Forty-four cases had been reported, with 11 severely ill, all linked to the Huanan sea food market. The news, so ominous in hindsight, passed largely unremarked. A few days later, on January 31^st, two Chinese tourists visiting York were the UK’s first publicised coronavirus victims. In the months that followed, lives and businesses changed in ways that would have been unimaginable at the start of 2020.

Covid-19 apart, 2020 also proved to be one of the worst on record for political and social unrest, economic contraction, financial market volatility, and sadly, an appalling death toll, family suffering and tragedy. Yet, with few exceptions, financial assets have pushed ever upwards, surfing a wave of liquidity meant to counteract the impact of the pandemic.

A new year is always a time for reflection but never more so than in the strange, muted first few weeks of 2021. Never can so many have wished so fervently for the old year to end and yet, only a month into the new year the gap between hope and reality seems as wide as ever. The early part of this year already looks very different from what was expected only a few weeks ago with Lockdown 3 being imposed by the Prime Minister on the 4^th of January. The new variants of Covid-19 have exponentially increased the transmission rates and sadly infection rates and deaths are increasing, and the NHS is again at risk of being overwhelmed.

The darkest hour, it is said, is just before the dawn and among all the atrocious news flow we must keep two basic facts in mind. The vaccines work and there are enough doses to cover vulnerable populations and healthcare workers so healthcare systems are not overwhelmed. The initial phase of the vaccination programme, involving care home residents, over 70s, and NHS and care staff, would protect 88% of those who have died so the death rate and hospitalisations will fall dramatically. It is entirely possible that the US and Europe will achieve this by early to mid-April. Within a few months, we should see healthcare capacity improving and complications, hospitalisations and deaths declining. Governments will be able to reopen schools, businesses, and economies. There will be complications and delays, in particular the uncertainty about the effectiveness of the vaccines on all variants of the virus, but reopening does not require vaccination of the entire population and could happen faster than expected.

While we are deeply concerned about the pandemic and the impact it has on all of us, we believe that we will overcome it and we are optimistic that the year ahead will gradually bring a sense of renewal and possibility as we apply what we have learned from the past 12 months.

What has the pandemic taught us?

So, what have we learned and how will the lessons of the past 12 months influence the future and the way in which we go about our lives?

An important lesson for businesses is the way in which Covid-19 has delivered a coup de grace to the weak, the debt-ridden, the hot air merchants and the greedy. Several high-profile collapses, including Debenhams, Monsoon, Laura Ashley, and Sir Philip Green’s Arcadia Group were in trouble before the virus, which accelerated their demise.

In a pandemic, well-run companies are also vulnerable but businesses with good governance, sensible debt levels and a solid business model stand more chance of survival. The business fundamentals of the companies in which the Clarion funds and portfolios are invested, are strong, the digital platforms and other businesses that have done well will continue to do so and the consumer, healthcare and industrial companies that have been held back will rebound strongly. Governments and their fiscal and monetary policy will be supportive, interest rates will stay low and inflation will mean that companies with growth and pricing power, and assets with scarcity, will do well.

The past twelve months has also taught us the value of running with a margin for error, just in case. We have learned that too much debt is dangerous. This should be obvious but apparently it is not. Businesses and individuals up to their necks in borrowing fall into trouble very quickly. The country now has a millstone of more than £2 trillion of debt, which is not an immediate problem whilst interest rates are low but leaves us less firepower for the next crisis.

Lockdown has also given us a greater appreciation of nature and a closer connection to the food that we eat. This will accelerate the pace of transformation in sustainability. We also now know that workers in critical services deserve a heightened level of respect and that needs to continue, with better pay and conditions. We need to be more focused than ever on the reward, recognition, and wellbeing of frontline colleagues.

We have learned that the technology revolution is in its infancy and will transform our lives much more than anything we have witnessed before. As individuals many of us have acquired new skills. We have learned to use Skype and Zoom to bridge the gap of separation from friends, family, and work colleagues. Productivity could finally be turned around through smarter, tech-enabled ways of working. Robotics and artificial intelligence could revolutionise everything from food shopping to elder care.

We have seen the development of vaccines with incredible collaboration and speed, reminding us that change can happen faster than we ever thought possible. We will start to see the healthcare industry transformed by the same kind of forces that have produced growth in technology-based businesses. Something akin to Moore’s Law, the rule of thumb that the cost of computing power halves every two years, will apply equally to healthcare, thanks to sequencing machine learning and other forms of artificial intelligence. The Covid vaccines are just the start.

Brexit hope

There are other reasons to be optimistic with Brexit being another source for hope. After many months of difficult negotiations, investors generally welcomed the new trade deal which was struck with only hours to spare before the chaos of a no deal Brexit. The agreement allows for tariff and quota free trade in goods between the UK and the EU and covers many other areas including security, transport, telecommunications, and energy.

However thin the trade deal may be, it is better than the short-term chaos of no deal. There is a view that the deal was done because Boris Johnson convinced the EU that he was willing to contemplate a no deal Brexit. However, a basic free-trade deal was always on offer and the EU has more reasons to be happy with it than Britain. Its comparative advantage is in goods, particularly manufactured products, and food; the UK’s is in services, particularly business, professional and financial services. The deal preserves the EU advantage, albeit not without friction, while doing little for the services that make up the vast bulk of the UK economy.

The Brexit deal may still cause some disruption in the short term but avoiding the chaos of no deal and a schism in the UK’s trading relations with other countries is better than the alternative. Alongside that, the International Trade Secretary has rolled over those EU deals and forged new trade agreements with other countries.

Over in the US, Donald Trump’s chaotic presidency hurtled toward a dramatic end, with his removal, impeachment for “incitement of insurrection” and prosecution. Mr Trump hands over a US that is less together at home and less credible abroad than at any point since the nadir of the Vietnam war, but a new, less controversial president provides reason for optimism. Donald Trump was president, but he was not a politician. America now needs a statesman; a politician and a president and Mr Biden is all three. Democratic victories in senate run-off elections in Georgia mean the new president has an opportunity to push through a far more expansive policy programme than had previously been expected. Green energy and infrastructure, and possibly even student debt forgiveness, are likely to be at the heart of President Biden’s plans, paid for by masses of fiscal stimulus, always popular with stock markets.

Across the Western world there has been a trend of households significantly upping their savings rates whilst corporations have gone on a debt binge to raise liquidity and extend the maturity of existing debt. This high household savings rate is one of the reasons economists expect a sharp rebound in 2021 as pent-up consumer demand can be readily funded, even as unemployment and corporate bankruptcies rise as furlough schemes and government subsidies are removed. Fiscal spending on infrastructure is also expected to pick up the mantle as transfer payments to individuals and businesses are wound down.

Weathering the storm

So, amid all the gloom there are several reasons to be cheerful and to hope for plenty of rainbows in the late spring and summer months but just like the English weather we must also be prepared for rain. The new variants of this pesky coronavirus are more transmissible and have surprised many people, including the scientists. Many were too optimistic about the course of the pandemic during 2020. A second wave was always a possibility, but the sheer scale and seriousness has been a surprise. We do not know how many more surprises this unseen enemy will throw at us, so we must be vigilant.

Another concern is how the UK Treasury deals with the fiscal hangover of the crisis. With a budget date set for March 3^rdthere is an understandable concern about possible tax increases. We must hope the Chancellor adopts a long-term strategy. The enormous costs of the pandemic will need to be paid for sooner or later, but tax increases now could derail the economic recovery. In the meantime, the current unusual combination of record deficits and very low borrowing costs looks set to last. This will provide breathing space for the Treasury in terms of the cost of servicing the debt and the Bank of England could do more quantitative easing and/or employ negative interest rates.

For stock markets January is probably the least bad month to have a national lockdown, particularly for the hard-hit leisure and hospitality industries. Markets had largely written off January in terms of a return to normal anyway, as well as probably February and also March. Even before the new variants emerged it was going to take time to roll out vaccination programmes and during this period it would be difficult to fully suppress a second wave of the virus in the winter flu season.

The economic consequences of Lockdown 3 are likely to be closer to those experienced in November as opposed to the first shutdown. Construction will continue, the housing market remains buoyant (UK mortgage approvals recently hit a 13-year high) and both Government and Central Bank policy will remain accommodative. For example, last month the furlough scheme was extended until the end of April and immediately following the lockdown announcement, the Chancellor revealed a £4.6 billion support package for Businesses.

More importantly for markets is that there appears to be an end in sight. The pledge to vaccinate the vulnerable and healthcare workers by mid-February (with a lag of several weeks for immunity and for hospitalisation rates to fall) should mean that, sometime in March, those in the age and vulnerability groups that have previously accounted for 9 out of 10 deaths in the UK will be protected against the virus.

While being cognisant of the short-term risks to the economy and broader markets, we remain comfortable with our overweight position in equities. The removal of uncertainty, an economic recovery supported by policymakers and pent-up consumer demand, as well as a market that is cheap, under-owned and with supportive dividend growth potential mean that the UK, and some Asian and Emerging markets, remain attractive on a multi-year time horizon. America is our least preferred option on valuation grounds but even US markets remain cheap relative to bonds and other asset classes.

With three vaccines now fully approved and being rolled out and with non-negative outcomes transpiring for both Brexit and the US election the post-winter economic future looks brighter than it has done for some years. In conclusion, we expect showers and perhaps even prolonged periods of rain from time to time but these will eventually give way to brighter skies and rainbows.

Covid 19 has caused massive disruption to all our lives with much human suffering and tragedy, but it is important to note that throughout this difficult period our operations have not been impaired by lockdown and travel restrictions. In addition to the delivery of very satisfactory investment returns, we are also proud that we have been able to maintain regular contact with all our clients. We have always been available and any requests for information have been dealt with promptly and efficiently. Whilst it has not quite been business as normal, we have strived to ensure that it has been business as usual.

As always, we wish all our clients, their families, and friends a safe passage in the early months of 2021 and we look forward to sharing a brighter future in the late Spring and beyond.

Stock market and economic commentary – January 2021

Stock market and economic commentary – January 2021

What has the pandemic taught us?

Brexit hope

Weathering the storm

Keith W Thompson

Clarion Group Chairman

January 2021

Creating better lives now and in the future for our clients, their families and those who are important to them.