No one could have predicted the outbreak of COVID-19 and the subsequent measures taken to contain it. The economic impacts of the pandemic reach far and wide but it isn’t all doom and gloom.
Where there is challenge, there is also opportunity and those that spot new or accelerating trends can reap rewards. At our investment webinar our panel of Rathbones’ experts discussed the investment outlook for 2021 and considered the long-term landscape for economic growth, inflation and debt. A full recording of the event is available here:
Over 1,000 guests joined us on Zoom for our investment webinar, during which we discussed the opportunities and challenges created by COVID-19. Broadcaster Andrea Catherwood hosted the panel and set the scene by looking at some of the trends which have been accelerated by the pandemic and asking what ‘build back better’ will really look like. Rathbones’ Edward Smith and Jing Hu went on to discuss some of the wider macroeconomic trends for 2021 before Sanjiv Tumkur and Rowan Marron examined the future of the business landscape and looked at specific opportunities.
Edward Smith CFA, head of asset allocation research, discussed the macroeconomic outlook for 2021
We are relatively optimistic about the global economy and financial markets but there are risks, and we’ll particularly focus on the two which we are asked about most frequently: government debt and inflation.
One of the most difficult things to adjust to last year was the speed of the economic and market reaction to COVID-19. Ordinarily, recessions and recoveries play out over months, often years but the economy retracted for just two months in the COVID recession, and the stock market troughed in two weeks. Globally, the stock market is already well above the pre-crisis peak and despite protracted social restrictions, the economic data hasn’t been as weak as expected. In the US, gross domestic product (GDP) and economic output should be back up to the pre-COVID high watermark by the end of the year and global GDP even sooner than that. Global trade and global industrial production are back above pre-COVID levels already.
Here in Europe, our economies were more fragile to begin with and the lockdowns have been harsher and more contracted which means that many European countries won’t recover fully until the end of 2022 at least. Unfortunately that includes the UK. We’ve had the second worst health outcome out of the 40 countries we keep track of, and it looks like we’ve had the worst or second worst contraction in 2020 economic output.
Risks remain. The complexities of distributing a comprehensive inoculation programme are clearly significant, especially in the emerging world. There’s also a risk of long-term scarring; several studies suggest previous epidemics have left economies 3%-4% smaller than what they would otherwise have been.
We need policymakers to continue to provide fiscal and monetary support for the foreseeable future and to guard against cyclical and long-term risks. All that support has led to a huge rise in government debt - should we be worried about that? There may be some academic evidence that’s quoted by fiscal hawks in the press that high debt is associated with low growth, but actually, the evidence for that is pretty weak and the point there is associated with, not necessarily caused by. In fact, work that tries to establish the direction of causation points more towards deficient growth causing high government debt. Our research suggests that now is not the time to worry about repaying that debt.
If the government retrenches into austerity while the private sector is also retrenching, the decline in overall output and therefore the tax base needed to service that debt may be so large that government finances may end up worse than they would otherwise have been had they done nothing at all. The most important thing is to ensure that the rate of economic growth exceeds the cost of servicing that debt.
Borrowing costs are very low for structural long-term non-COVID reasons and that’s highly likely to remain the case for the next five years. Economists are increasingly admitting that for countries that can borrow in their own currency, the only real constraint is inflation. We don’t think that a prolonged period of intolerably high inflation is a high risk, at least over the next couple of years.
Governments should use their budgets functionally and make up for where the private sector is deficient or lagging behind. For us, that means public investment in areas such as digital infrastructure, green infrastructure, transportation. These are the areas that are likely to crowd in private investment, rather than crowd it out. We think that countries that engage with this might have better structural growth prospects.
You can find out more about our views on government debt in the investment report on our website.
Jing Hu CFA, senior asset allocation analyst, outlines our views on inflation expectations
Setting an inflation target at 2% allows for price stability and avoids deflation, which would be more damaging than the same amount of positive inflation. As interest rates tend to rise as inflation does, moderately positive inflation allows policymakers to cut rates when facing an economic downturn.
Last year, global central banks and governments initiated an unprecedented level of support to minimise the economic damage incurred by households and companies. A lot of us began to wonder whether this free money would affect inflation. Consistently high inflation is one of our key risks to economic recovery, but one to which we only assign a low probability.
An increase in the supply of money doesn’t necessarily lead to inflation. Many commentators warned of sky-high inflation after central banks first expended their balance sheet with then novel quantitative easing in 2008, and yet, inflation has consistently undershot the 2% target for the past decade. It isn’t just supply that matters, it’s the use and reuse of the money that’s important. For inflation to move towards central banks’ targets, high street banks need to have the confidence to lend, and the companies and households need to be willing to spend and invest.
Will the banks be generous with their lending in future? Central bank bulletins suggest because of the severe economic impact of COVID on borrowers’ credit worthiness, banks are likely to tighten their supply to the private sector and that is disinflationary. From the consumers’ perspective, when we face economic uncertainties, we tend to turn cautious on our spending and hold cash as uncertainties over our job prospects rise. Again, that’s disinflationary. During the second quarter of 2020, UK households’ savings ratio jumped to over 25% before cooling back down to 17% which is still very high by historical standards.
To pull all these considerations together, it’s clear that it would take time for aggregate demand to recover and for spare capacity to disappear and as a result, we don’t think the inflation threat is imminent. We do expect a temporary increase in inflation to between 2 and 3% in the spring and early summer, due to food prices, shipping costs, and very low pandemic-inflicted prices in 2020 (what we call “base effects”).
Inflation is as much an institutional phenomena as it is a monetary one. As long as our institutions remain credible, the chance of inflation spiralling out of control is very low. We believe that the independence of central banks is still intact.
Equity markets will be the place to be and that’s because companies will receive healthy growth in demand, allowing them to grow revenue while passing on increased labour and material costs but sometimes things don’t go as expected. We don’t rule out the possibility of policy mistakes being made and that will have consequences. Our analysis shows that when inflation rises above 4%, the return from equities in aggregate would get hurt, and there would be a strong case to focus on quality companies with very strong pricing power in an equity-orientated portfolio. Gold and index-linked bonds are likely to outperform.
What’s important is how commercial banks turn money into lending, and the private sector’s demand for the money. With spare capacity in the economy and incentives for companies and households to hold cash, inflation is most likely to remain tame.
You can read more about our views on inflation in the investment report on our website.
Sanjiv Tumkur, head of equity research, discusses the impact COVID has had on different companies
2020 saw a significant drop in global economic activity driven by COVID lockdowns, with the IMF estimating that global GDP fell 3.5% in a year but, despite this, equity markets didn't collapse. Governments stepped in swiftly to sustain economic activity by printing money and borrowing in order to finance furlough payments, stimulus cheques and business support. Unemployment didn’t rise to levels first feared and therefore the long-term harm to the economy was partly mitigated.
There were some predictable winners and losers in 2020, and some more surprising ones. Defensive and resilient sectors, such as healthcare and consumer staples, outperformed, but the more economically sensitive sectors, like oil and financials, fell. Some sectors which are usually quite cyclical and might have been expected to suffer also ended up outperforming, for example mining and industrials. Among the losers were businesses which saw shutdowns or significant loss of business from COVID, particularly the leisure sector. In November we had good news about vaccine discoveries which increased the prospect of economic recovery in 2021, causing the losers to enjoy a bounce.
Technology was the absolute standout performer of 2020. The sector is normally fairly cyclical as it’s driven by corporate capital expenditure budgets, however in this downturn, technology played a crucial role in enabling working from home, learning from home and staying at home. Pre-existing trends, including online shopping and food delivery, sharply accelerated, with many of us using these services for the very first time and finding that we liked them. E-commerce powered ahead as consumers shopped online due to store closures or reluctance to spend too much time in enclosed spaces.
A classic defensive sector, healthcare, also performed well in 2020 as demand for medicine remained resilient in tougher economic conditions. There has been greater focus on wellness, through the increased adoption of things like fitness apps and more demand for over-the-counter remedies such as Nurofen. Pharmaceutical companies have long been in politicians’ crosshairs, particularly in the US over excessive medicine pricing, but through COVID, they have demonstrated their value to society as they quickly devised the new vaccines that the world so desperately needs to return to normality.
Rowan Marron, takes a deeper dive into the retail sector
Total retail sales held up relatively well last year. They were down 2% for the UK which is a little bit weak but certainly not catastrophic and considerably better than you might expect given the impact to GDP. The so-called stay at home categories, such as DIY or pet care, did quite well. Travel suffered and clothing stands out as particularly hard hit, down 25%.
Some changes to consumer behaviour will be sticky, some will reverse. For example, the proportion of retail sales online this year will be higher than pre-pandemic, but may be down on 2020. Stores will hopefully be open again fairly soon, and we will want to return to doing things with friends that we can’t do online. But some consumer behaviour is sticky, for example, older consumers who have learnt how to order groceries online may keep shopping that way.
Clothing is fairly weak as we all sit here at home not needing work or party clothes but hopefully that demand will go back to normal eventually. On the other hand, if you consider DIY, lots of people have already painted their house in 2020 and they may not want to do it again in 2021. There is scope to see declines in sales.
While 2021 is not completely normal, we all hope it gets back to a much more normal situation reasonably soon. Looking at market expectations for 2020 generally losers are expected to rebound and 2020 winners like DIY and supermarkets, to be fairly weak. There are two names worth highlighting as an exception to that trend: Hut Group and Boohoo, both online-only names. They are expected to generate 25%-30% revenue growth again this year, on top of a very strong 2020.
Two case studies: ABF owns Primark which was a lockdown loser as they don’t have a transactional website. When their stores shut, they made no revenue. However, I think it’s potentially a post-lockdown winner. Firstly, there are the general benefits of people buying clothes again when things return to normal. There are also specific benefits. Lockdowns have killed a number of store-based retailers, especially in apparel which means there is market share up for grabs for the survivors. The UK is likely to have a relatively weak economy and elevated unemployment which make good conditions for discount retailers such as Primark.
B&M was a lockdown winner, with stores open throughout, revenue growth greater than 20% for most of last year, and lots of new customers in the doors. The question is whether they can hold onto their gains. The market expects revenue this year about flat on last year. The best hope is that the new customers, about 20% of 2020 customers, will keep shopping there now that they’ve found the company. On the other hand, B&M made a lot of cash over 2020 and is now paying it out in special dividends, which may cushion any disappointments. And, like Primark, it’s a discount retailer.
What you want isn’t necessarily stocks that do well in an absolute sense, but stocks that do better than the market expects. So, don’t necessarily write off store-based retail. Some of the survivors have quite good prospects and some of the online names by contrast may struggle to meet very high expectations.
Sanjiv concludes by discussing our investment position for 2021
COVID has accelerated many of the existing trends around ecommerce which we have seen over the past few years. Sectors which have benefitted will see an element of altered behaviour unwind in 2021 and 2022 as life slowly returns to normal. Sectors which have suffered should see some improvement. We do expect a degree of behavioural change to persist - for example, many people will work more days a week from home than they did before COVID and business travel could be dramatically lower. When thinking about what the ‘new normal’ could look like, we need to examine issues such as potential de-urbanisation and lower birth rates in developed countries, higher savings rates and possibly elements of de-globalisation.
We think 2021 could see some of the 2020 losers enjoy a period of recovery. It would make sense to have some selective exposure to some of these areas with a quality bias in the form of quality cyclicals. Responsible investment – driven by increasing governmental commitments to meet net zero carbon targets by 2050 – and technology look set to be enduring themes where we see plenty of interesting stock opportunities. We still feel uncertain when looking at the future and the recovery. Companies with robust business models, strong competitive advantage, good pricing power and an ability to adapt to changing conditions should continue to outperform longer term. Stock selection will be as important as ever, if not even more so.
