I hope you were able to stay safe and enjoy the holidays and I wish you a very happy and prosperous 2021. Expectations are high but the first days of the year have reminded us what we hope to leave behind – a spiralling pandemic and a dysfunctional American president. Yet markets are forward looking, and the twin supports of super-supportive policy and vaccines remain solid props for the outlook. People are talking about the roaring 20s. The light after the dark. The spending after the saving. It’s an enticing scenario. As long as conservatism doesn’t take over policy making it’s an outlook that keeps me of the view that risk will perform, and markets will bounce back from any setbacks.
Two out of three
The trifecta is two-thirds done. Brexit is complete and there is a free trade deal between the European Union and the United Kingdom. Trump is almost gone having finally conceded defeat the day after the Democrats gained control of the Senate and the world was shocked by the mob-antics of his supporters in Washington, D.C. Seeing the back of Brexit and Trump removes two sources of anxiety that have weighted on investors for some time. Now we need to see progress against the pandemic. On that front, the number of vaccines administered across different countries will become an important metric of markets. For once, the UK seems to be doing quite well on that front.
Restricting the virus
A successful vaccination programme reduces the size of the potential host population for the virus. So even though transmission rates appear to have accelerated in many countries – not least because of mutations to the virus itself – there should also be an acceleration of progress towards herd immunity in the coming months. The R0 rate might remain high but reducing the number of infectible people will have an impact on both the absolute numbers testing positive and the absolute number of people requiring hospital treatment. This is especially the case if the most vulnerable are vaccinated first. Quite possibly we could see a very steep drop in new cases, hospitalisations and deaths.
If that positive scenario does emerge then what follows will be the lifting of social mobility restrictions and the re-opening of sectors of the economy that have been hit by rolling closures over the last year. This is not likely to happen quickly given the risks that will still remain, especially those associated with travel, but things should be a lot brighter than they have been. Pent-up consumer and investment demand could contribute to a boom in economic activity in the second half of the year. The anticipation of that should support investor confidence, flows to risky assets and a further improvement in corporate earnings momentum.
After the global financial crisis, balance sheets were damaged. In the US, both the corporate and household sector had to move back into financial surplus given the credit constraints that followed the sub-prime crisis. This curtailed spending and contributed to a very sub-par recovery. This time things are different. The US household sector is much stronger. Because of the lockdowns, spending was curtailed, and the savings rate shot up. According the to the Federal Reserve’s Flow of Funds data, the personal savings rate rose to 25% in Q2 last year, was 15% in Q3 and was very likely still around 12-13% of disposable income in Q4. This is huge bearing in mind that the savings rate averaged just over 7% between 2009 and 2019. Moreover, net worth has surged. In the post-2008 period net worth fell by 15% between Q2 2007 and Q1 2009. This time around it increased by over 7% between Q3 2019 and Q3 2020. Monetary policy delivered rising financial asset and house prices higher during the pandemic and they continue to rise.
I am talking in aggregate here and clearly inequality is a major social issue, which will inform the policy agenda of the Biden Administration. Not all households benefit from higher equity and home prices. The unemployment rate was 6.8% in November and the fall in initial claims for unemployment benefit has stalled. There will be some in the new Congress that will take every opportunity to state that the rich have got richer, but the poor have got poorer. But for the economy as a whole, the strong position of the majority of the US household sector is good news. It is highly unlikely that the savings rate will remain at the current elevated levels. That means more of income and some of the accumulated stock of savings will be spent in the quarters ahead. What will it be spent on? Well, most likely on what it couldn’t be spent on for the last 10 months – travel, hospitality, leisure and so on. I’m not sure it is a reason to go out and buy the stocks of airline operators or hotel groups, but activating savings to boost aggregate demand will be beneficial for the economy overall and this should be supportive for further upward revisions to corporate earnings.
Moving on, a dollar recovery ahead?
So far, the US and the UK are ahead in the vaccination programmes (although Israel has reached a higher percentage of its population than anywhere so far). The US could get quite a boost from the combination of vaccinating large numbers and allowing pent-up spending to materialise. Combined with additional fiscal stimulus the growth numbers could be quite something. My guess is that means, politically, the dark days of the end of the Trump Administration will quickly fade from the collective memory, and that the bear market in the dollar could quite quickly reverse at some point this year. It’s unlikely that Europe will roll out vaccinations as quickly nor see as strong an economic bounce. Euro-dollar might well hit the $1.30-1.40 range, but I wouldn’t rule out a reversal back to $1.20 after that.
One important implication of the Democrats gaining control of the Senate in the wake of the Georgia run-off elections is that Biden’s ambitions on greening the American economy have more chance of being translated into actual policy. This should mean more investment in renewable energy, an increase in electric vehicle use and production and a more rapid energy transition generally across major sectors of the economy. The strong performance of stocks related to the clean energy theme is likely to continue as a result. There is also likely to be more green bonds issued in the US to support investment in these themes. Following the November election, it was widely reported that President Biden would take the US back into the Paris Agreement and update its emissions reduction targets from those last provided by the Obama Administration. This will be a strong message ahead of the COP26 meetings later in the year and provide incentives for capital to flow to climate change related investment strategies.
While there is the potential for an economic boom and another good year of returns from stocks, there are plenty of risks and reasons to be watchful. The first is that the pandemic remains extremely damaging to human and economic life. We need to see infection rates peak, less people getting ill and a critical mass of vaccinations being reached. If there are doubts about the efficacy of the virus in the field, logistical or bureaucratic disruptions to supply or reasons why significant numbers of people won’t take it, then sentiment could be seriously undermined. An IPSOS poll undertaken before Christmas in a number of countries suggested that between 60% and 80% of people polled would get the vaccine when it became available. Worrying, in France, the poll number was just 40%.
Another risk – although one I would not attach a high probability to for the foreseeable future – is a backtrack on the policy setting. Any return to fiscal austerity or a premature tapering of asset purchases would be very disruptive to markets. I don’t necessarily think it is a problem that asset prices react positively to policy support – after all, policy makers are merely making up for deficiencies in the private sector when economies are hit by a shock. But that means if the withdrawal of policy support comes to soon and too rapidly, asset prices will suffer. The combination of Biden’s progressive ambitions (if not policies enacted fully), Yellen at Treasury and Powell at the Fed tells me the US policy framework will remain supportive for the economy and, hence, markets. I suspect the same goes for Europe.
Finally there is the legacy of the Covid recessions. Output gaps will remain substantial for a while, long-term unemployment may stay stubbornly high. Some sectors will never recover – it’s hard to see high streets being repopulated with low-end clothes shops again. Urban geographies will thus be changed and that requires a re-think for town planners and zoning policies. We don’t know what the long-term impact on social behaviour towards mobility and interactions will be. Certainly, it has been proved that technology can help fashion new ways of working and commerce. A lot of this will be permanent and policy will have to address making sure access to technology and a more flexible way of working is widespread across society. There will be scarring from the pandemic and that puts an enormous burden on social, fiscal, educational and health policies going forward. Failure to recognise the scarring from the global financial crisis arguably led to the rise in populism, support for Brexit and other manifestations of dissent within the EU, and a worrying decline in international trust and co-operation. Let’s hope that lessons have been learned.
A real race?
If I’d been told Manchester United would be second in the league at the start of the new calendar year, I would have taken that. In fact, it’s even better than that because United and Liverpool are on the same number of points but United currently have played one game less. Below are a number of clubs that are genuine contenders – Leicester, Tottenham and Manchester City and even Everton and Aston Villa (though I doubt they will be able to sustain the proximity to the top of the table all season). It could be an interesting few months. I hope that game in hand translates into three points and it becomes a real race for the title. Be good if there were crowds to see it. Eventually there will be but, in the meantime let’s hope football can steer through the Covid-mess.