Investors should brace themselves for a powerful economic recovery from the coronavirus crisis – but shouldn’t necessarily expect it to translate into stock market returns.
This is according to Matthew Tillett (pictured), manager of the Brunner Investment Trust.
There is a growing consensus that the roll-out of coronavirus vaccines in Europe and the US, and eventually the rest of the world, will lead to a sharp bounce-back in economic activity.
The rationale behind this is fairly obvious – the release of pent-up demand. However, Tillett said there are two other forces that will be just as important in helping the recovery to outpace those in the past.
“It is not just the fact that people have been sitting at home and haven't been able to do what they wanted,” the manager explained. “It is also that a lot of people are actually better off than they were before, because the government has provided so much support.”
The final reason is that this government support, in terms of both monetary and fiscal policy, is likely to remain in place until the recovery is well under way. For example, it was suggested last week that chancellor Rishi Sunak is set to extend the furlough scheme and business rate relief into the summer.
Tillett said this is an important difference with what happened after the financial crisis when there was a “fiscal retrenchment”, particularly in the West.
“We don't have that same consensus view among policymakers and the electorate about the drive for austerity, this belief that government debt needs to come down,” he continued.
“That just doesn't seem to be on the cards. In a way, you’ve got the perfect environment for quite a strong recovery. I find it hard to disagree with that consensus.”
However, while a strong recovery could well give people more confidence to invest in equities, it is important to remember there is an erratic relationship between the economy and the stock market.
Tillett said the connection is likely to be especially weak in the coming months and years. For example, he pointed out that while the market is always forward looking, it already seems to have priced in a perfect recovery in sectors that face an uncertain future.
“If you look at the cyclical areas of the market like travel, hotels or outdoor-event companies, some of them are already back to where they were pre-Covid,” the manager said. “Yet their business is a fraction of what it was. You’re scratching your head a bit when you look at that. Are those sorts of stocks really going to continue to outperform at the other end?
Performance of index over 1yr
Source: FE Analytics
“Then you had this huge rally in the early to mid part of 2020 in all of the companies that were beneficiaries of working from home and the Covid restrictions. Many of those companies are still at all-time highs. So it's a more nuanced picture when it comes to how the stock market might behave.”
And the manager warned that a strong recovery could even have negative implications for the market.
For example, he said that once the economy opens up and there is a surge in demand for goods and services, this will lead to inflation if supply cannot keep up. This will be exacerbated as the enormous amount of money created by central banks begins to move faster through the economy, putting upward pressure on interest rates and bond yields.
However, Tillett said the question is whether this will lead to a short-term spike in inflation or a sustained increase in prices over a longer period of time.
“Structurally, there are more reasons to think that inflation will happen now than there were, say, 10 years ago,” he continued.
“The big change is that we don't have the same kind of deflationary force from these pools of low-cost labour, particularly China, that were able to keep down the cost of tradable goods.
“If that's going to dissipate, then you'd expect the overall inflation numbers to be structurally higher going forward.
“On the other hand, technology has come a long way as well over the last 10 to 15 years. A lot of the digital economy is deflationary as technology allows you to provide cheaper products to the customer.”
The manager is not positioning Brunner for either one of these inflationary outcomes. He described it as a one-stop shop rather than a trust of extremes and said he balances the investment case between quality, growth and value when buying a stock.
Tillett added that there are many structural trends that will have a much greater impact on the market over the long term than the fallout from Covid and said it is a better use of his time to focus on these instead.
“Whether it is the digital economy, demographics or energy transition, these things will continue to be with us for many years to come,” he said. “We're more focused on actually understanding those trends and making sure that we're going to benefit from them.
“Maybe some of them will be a bit more cyclical than others and will benefit if interest rates go up, because they are financial companies, for example, while others might not. We're trying to make sure that the portfolio's performance is not going to be totally thrown off course by one of those possible macroeconomic outcomes.”
Data from FE Analytics shows Brunner Investment Trust has made 179.19 per cent over the past 10 years, compared with 183.42 per cent from its IT Global sector and 147.58 per cent from its benchmark, split 70:30 between the FTSE All World and the FTSE All Share.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
The trust is yielding 2.23 per cent. It is on a discount of 11.56 per cent, compared with 11.82 and 10.2 per cent from its one- and three-year averages.
It has an ongoing charges figure of 0.66 per cent.