Light at the end of the tunnel


We are now in the ninth week of ‘lockdown’ and the drastic social distancing measures designed to fight the spread of Coronavirus. The good news is that these measures have been very effective in reducing the rate of infection and we can now see some light at the end of the tunnel.

We are now beginning to have some clarity of the enormity of the impact of Covid-19.  Despite huge intervention and financial support, governments are not going to be able to save every company in trouble.

No ‘short sharp shock’
The Bank of England has warned of deep recession and the sharpest downturn in the UK since 1706, predicting a 14% fall in GDP for 2020 and unemployment rising to 9%. These figures are not just of concern, they are alarming, particularly when compared with data being forecast elsewhere.  Bizarrely, the BoE is also forecasting a 15% GDP recovery and zero inflation in 2021. We are already reading reports that dispute the BoE’s views.

In Europe, where lockdown was introduced a little earlier, the European Commission forecasts the Eurozone is heading for its worst GDP contraction on record at 7.75% for this year; Greece will be down 9.7%, Italy 9.5%, Spain 9.4%, France 8.2% and Germany 6.5%. Sweden, which took a different approach to the crisis, is forecast to see a reduction in GDP of 7% this year according to Olle Holmgren of SEB Consulting, so there is no evidence that preventing the healthcare system from being overloaded whilst avoiding drastic lifestyle changes will be any more successful economically than a more forceful lockdown.

It looks like a W-shape
Hope for the V-shaped recovery has consequently evaporated, our friend Ed Harrison at now holds the base case to be a “depression with a small d”. He sees the virus “hanging around for the long-term, shifting consumer behaviour and disrupting the economy for months and years to come, and that will mean an L- or W-shaped economic outcome as we only slowly regain our footing in the post-coronavirus world.” He uses the term ‘small d’ because he sees Government and Central Bank policy action decisive in stopping what would normally be worse than a recession – a full blown Depression.

Markets – more resilient than expected
Despite plunging by 34% from January to 23 March, the FTSE-100 Index has recovered with a gain of 18%.  Likewise, the S&P has been even better, falling 31% but recovering 29%. This has shown some resilience in markets, but realistically, given the mounting evidence of the size of the economic hit this year, we have to expect some continued significant volatility as we see increasing news of job losses and bankruptcy.

Remain invested – UK shares are cheap
Unfortunately, UK equity funds have not performed as well as international funds for the last three and a half years following the Brexit Referendum.  Many UK companies such as Shell, BT, Babcock and BAE were looking seriously undervalued against global brands such as Microsoft, Apple, Facebook and Netflix. But now, at current prices, it could be argued they are looking exceptionally cheap.

Add to the UK
The UK economy is going to recover and there will be significant stimulus applied by Government, particularly in infrastructure, construction and housebuilding. As an example, consider housebuilders Barratt Developments; the share price has fallen over 40% since February but like many similar companies, they are in a much better position today than they were after the last crisis in 2008 – they have little debt, a strong balance sheet and a large landbank. The P/E (price of the share to the earnings of the company) is less than 8 and the current dividend is 7.5%.  No-one doubts that it will be a difficult 2020 but this is a good quality company that should do well over the next few years and therefore a good long-term buy. Associated companies in these sectors that are attractively priced today include Howdens and Travis Perkins, both suppliers to the construction and housebuilding industry.

Sovereign Debt – a sector to avoid?
Despite the difficult current economic situation, we remain of the opinion that a portfolio of shares in good quality companies will provide the best opportunity for capital growth and income over the medium to long term. Government bonds, traditionally seen as a low-risk ‘safe haven’ now looks exactly the opposite. The yields (expressed as the income to the price of the bond) have been driven to historic lows and therefore the price of the bonds are at all-time highs. Investing in 10-year UK Government Bonds today yields just 0.25% if held for the term – this will guarantee a loss in real terms after taking inflation into account.

But with all central banks announcing that they will directly purchase the newly issued debt of their National Government and Government Debt levels set to soar as a percentage of GDP, it raises fundamental questions as to the underlying risk of holding Government Bonds. At some stage, markets will challenge the logic of investing bonds that offer no income and the guarantee of a loss of purchasing power.  The only buyers of this debt will be Central Banks.

Alternative investments
As many of our clients are aware, we believe in diversification in real assets. Many of our investors in FIM Forest Funds will be receiving bulletins from Gresham House with an update on distributions.  At the moment, timber prices remain reasonably firm with strong demand for pallets, fencing and biomass for energy, but may soften as demand for construction timber falls this year. FIM will reduce cropping and retain the timber ‘on the stump’, until demand again picks up.  In the meantime dividends may be cut for 2020. FIM will not be using raised capital to support dividends and have seen recessions before in their 35-year history.  We have every confidence in them and the management of the funds.

Gold demand has surged over the past few months and demand for investment coins has led to supply shortages. The price per ounce remains at an all-time high in GBP terms. We remain of the view that gold should form a small portion of a diversified portfolio and provides a hedge against inflation over the long-term as well as offering liquidity and security.  When judged over the next decade, gold will prove to be a far more reliable and a safer investment than Government Bonds.