The market story of 2020 looks dramatic but is relatively simple to understand, at least until the autumn of last year. A promising start to 2020 was upended by an unprecedented response to a global pandemic which swiftly threw the world economy into a tailspin dwarfing 2008. Swift fiscal measures ensued in the form of $11trn of additional government spending around the world according to the International Monetary Fund. Monetary policy response was equally dramatic, with interest rates brought down either to zero or into more deeply negative territory across the advanced economies. Quantitative easing programmes were re-started by all the major central banks, having been largely wound down over a decade following the global financial crisis. A market recovery led by technology stocks ensued from late March 2020 and continued until September as consumers stayed at home and devoured goods and services provided by tech or tech-enabled companies. But since then, cyclical stocks tied to the economy staged something of a comeback and are now claiming market leadership over growth stocks that have a high proportion of intangible assets driving future cash flows, i.e. technology. This included a US election with an untidy aftermath, a spike in Covid-19 cases in the US and Europe prompting more shutdowns, a second economic contraction as a result and now the roll-out of viable vaccines. While the market had a strong December, investors still need to decide whether to position for a vaccine-driven recovery on the one hand or a decades-long economic stagnation on the other. Just as in March, they are faced with a decision that will have an outsize effect on future portfolio returns.
W-shaped: US equity market stopped to think in the autumn before resuming progress:
If it seems reductionist to frame an outlook in terms of which of two ‘stories’ markets are likely to follow then it is for good reason. Robert Shiller’s Narrative Economics describes how stories themselves have the power to drive investment outcomes: “Narratives appear to us, we do not dream of equations or geometric figures without some human element”. And there surely cannot be a more human theme than the Covid-19 virus and our response to it. Pfizer’s heartening vaccine news in early November, followed by Moderna’s and then AstraZeneca’s suggest that all those cyclical sectors that had become unviable may, at last, have a future after so many months of uncertainty around their business models. The S&P 500 airlines sub-sector accordingly leapt more than 14 per cent on the day of the Pfizer news. There will of course be challenges along the way. Pfizer’s vaccine, for example, demands dry-ice transportation at -70 degrees centigrade and it appears that while there is circa 90 per cent assurance of symptoms not arising in the vaccinated, there is not yet the assurance that they won’t still be able to spread the virus. This means that ‘masks and metres’ will not end until well into the vaccination programme, i.e. the second half of 2021. It will therefore be darkest before dawn this winter as US and European caseloads soar amid new strains of the virus and further rounds of lockdown and distancing measures are mandated. But the end of the nightmare is surely in sight, with full normalisation of economic activity at some point in 2021 now a near-certainty. The market reaction since November – in which cyclical sectors drove the entire market – demonstrated that investors have begun the process of pricing this in.
However, the hard-headed case against this story is that too much damage and disruption has occurred – and is still on-going – leaving the economy weaker than it was before. Recessions in the post-war period in the US have tended to result in a ratchet-down of economic trend growth levels, in other words, recoveries from recessions have developed a bad habit of only being partial. Those with longer memories will recall the good times of the late 1980s and of course the 1990s Clinton boom with its internet-based communications and productivity revolutions. But those GDP growth rates of 4 per cent-plus in the US were not replicated in the 2003-2007 housing expansion and few will have happy economic memories of the post-global financial crisis recovery beyond the fact that everyone could get a job if they wanted one. Average wage rises reflected low levels of productivity growth, so it was hardly a golden age. So for a window into the post-Covid world of second-half 2021 and 2022, think 2019 – only a little worse. The virus may well be vanquished by then but the extent of the devastation and scarring will soon become clear. As for a modern Marshall plan, the idea is a sound one but advanced economy governments are broke. For all the breathless talk of a ‘new orthodoxy’ by adherents of modern monetary theory, economists and governments remain undecided on whether infinite borrowing in conjunction with central bank quantitative easing really is without adverse consequences. Reviews of capital gains tax, road pricing and multinational corporate taxation suggest that the UK government for one is not so sure. Furthermore, for all the talk of building back better and a new ‘Roaring 20s’, a post-Covid world will still face the enormous challenges of the pre-Covid world. Inequality, stalling innovation, low productivity, shrinking workforces and climate change have not gone away as attention has been lavished on the virus.
Partial to an incomplete recovery: trend growth ends up lower after each crisis:
This stark assessment is not intended to depress – day-to-day life is absolutely set to improve for those of us living under lockdown restrictions and that will bring much-needed joy. But the world economy is surely set to settle down into a ’95 per cent version’ of 2019 with all its attendant challenges. In the short term, markets will follow the twists and turns of lockdowns and vaccines, as well as US politics and other drivers of sentiment. And further vaccine approvals with more details on roll-out and normalisation will likely have a positive effect on cyclical sectors for a time. But the bigger story in the coming months and years will be one of renewed and deeper economic stagnation, with loose monetary policy the primary policy response. As Fed chair Jerome Powell stated in a recent European Central Bank-hosted panel discussion “We are now in an era of lower rates, but really that trend was in place beforehand.” Stocks as a whole will remain the right asset allocation choice given low interest rates, but outperformance later in 2021 will continue to demand structural weightings to stocks with high proportions of intangible investment that can generate future cash flows in the face of economic underperformance, including technology, biotechnology and selected technology-enabled business models. This can always be complemented by a more tactical satellite-style approach to cyclical stocks to capture positive news around normalisation in the near-term. That way, investors can enjoy the recovery now while being coolly realistic about the coming years.
Julian Howard is investment director at GAM. The views expressed above are his own and should not be taken as investment advice.