Six months ago, we were hoping the ‘Covid Crisis’ was going to be a short, sharp shock to the economy after which would come a classic V-shaped bounce-back. Sadly, those hopes were dashed by the second wave in October followed by further global lockdowns in November and now the imposition of Tier 4 restrictions covering London and the South-East.
Right now, we are in a pretty grim place, as summed up by Ed Harrison in his Credit Writedowns piece last week. “The near term economic data is deteriorating at an alarming rate in the US and Europe,” writes Ed, “and that creates short-to-medium-term business bankruptcy and personal income risks that are so deep, they could become long-term in nature”. The sentiment is shared by TS Lombard, the City’s leading economics and markets consultancy, to which we subscribe. Their view is “there remains the risk of winter virus spreads, lockdowns and another round of weak GDP”.
With so much doom and gloom around, it’s easy to feel powerless. But at 2hWealthcare we are looking beyond the bleak midwinter and into 2021 and our feeling is that the rollout of vaccines will be a complete game-changer.
The mass adoption of these vaccines in the developed world is going to drive huge pent-up demand growth. We forecast a strong synchronised global recovery, probably evident by quarter two 2021, and this recovery will be expansionary. This is going to be good news for markets.
A host of factors support this conclusion on increased spending, not least the building up of private sector household savings since the start of 2020 – $2.2 trillion in the US and £100 billion in the UK, according to James Ferguson of Macro Strategy and Andy Haldane, chief economist at the Bank of England. And there will be no return to austerity: Governments will continue to spend money for job creation and growth. The appointment of Janet Yellen as US Treasury Secretary by new Democratic President Joe Biden is a clear statement of intent.
In the UK, despite all the talk of deficit and debt concerns, Chancellor Rishi Sunak will be increasing government expenditure, not reining it in. All central banks will maintain loose monetary policy through low interest rates and asset purchases in the open market (Quantitative Easing), keeping the yields on government debt ultra-low. Inflation targets will be allowed to soften, so with some supply chains disrupted, lower inventory and increased demand, it is quite possible prices could creep up through 2021 and into 2022 and central banks won’t rush to act.
Winners and losers
From an investment position, equities will be the asset class to hold during this recovery. Pre-vaccine winners have been those companies who have benefited from lockdown and working from home – home entertainment, on-line retail, pharma and IT – while the losers have been energy, financials and industry. What all commentators agree upon in this coming recovery is a rotation from ‘growth’ stocks to ‘value’ stocks, and ‘defensives’ to ‘cyclicals’.
This is where we could finally see some improvement in the UK stockmarket. Our leading 100 companies that make up the FTSE-100 Index are predominantly oils/energy, financials, industrials and consumer spending sectors that have been extremely badly affected by the Covid crisis. Add to this the negative sentiment of Brexit since 2016 and it is no wonder the UK has been one of the worst performing stockmarkets of the past 12 months, down 13%. As we stand today, UK stocks have not been so cheap against their global peers for 50 years.
A deal with the EU – which may finally be revealed before you read this – would also help a positive revaluation of UK company shares. Two large-cap UK stocks worth mentioning as examples are BT and Vodafone. The former trades at less than a third of its net asset value, has a price/earnings ratio of just eight and a yield of 5%. The price is barely higher than it was when it listed in 1984. But it is now getting broadband right, looks on track for 5G and the pension deficit and high capital expenditure are all in the price. Vodafone will wipe out its £28bn of debt by listing its telecom mast business with a value of €20bn in 2021. It currently trades on a price/earnings ratio of 15 and has a dividend yield of 6.53%. The share price is 50% lower than it was three years ago.
Buying individual shares is regarded as a higher risk, but good UK funds such as Schroder UK Income Growth PLC offer a diversified UK portfolio and a high dividend yield and are very attractively valued. For a riskier play on value stocks, Temple Bar could see a huge turnaround in fortune. Mid-cap and small cap stocks are also likely to outperform over the medium term as confidence returns into 2021.
The US stock market has been a tale of two markets: Large-cap tech has run up well during the crisis but just eight of these stocks account for 35% of the S&P 500. Better value lies in Europe, where many markets have yet to recover. We also like the Far East, where these emerging market countries have handled the crisis well and strengthened their supply chains, offering good support for continued growth.
There is also much commentary on the traditional 60/40 equity/bond allocation. The general view is that fixed income bonds won’t provide a hedge on equities because the yields are so low and starting to rise. We go one further: Holding fixed income for the long term is going to be a sure way to lose purchasing power as the only way is down for government debt. We have positioned out of long dated fixed income and concentrated on equities in the UK, Europe and the Far East.
Prospects for property
Property is going to remain a problem for a while. Many funds remain suspended as managers use this period for selective sales to build liquidity to meet expected demands for withdrawals. Improved property demand will come with economic recovery and alternative usage in a post-Covid environment but it will take some time. Long term, property will still be a good inflation hedge.
Our message throughout the year has been to sit tight and take no action on portfolios. We maintain this advice and look forward to emergence from lockdown and a strong recovery. The recovery will bring a market improvement, and with our portfolios overweighted to equities and the UK, we are optimistic that 2021 and 2022 will see a significant improvement in values.
The 1920s in the United States were dubbed the ‘Roaring Twenties’, a period of optimism after the carnage of the Great War. There was strong economic growth and the stockmarket soared on the back of pent-up demand and plenty of available liquidity. It would be no surprise to us if the 2020s mirrors that experience. But a note of caution: We need to remember how the 1920s finished – in a spectacular collapse that heralded the Great Depression. Government bonds will be the canary in the coalmine here, so we will be watching them closely.