Investment Strategy:  Fourth Quarter 2020 – Macro…a little better?

The world’s economists (those crazy guys) pump out a lot of print, but it can be a bit tricky to get your head around it some of the time.  They certainly didn’t help by annualising the dreadful falls we saw in the second quarter, so as to make it appear at first glance that growth would fall by around 33% for the whole year. In reality, it plummeted for just those few months and has been tentatively recovering ever since and global GDP growth in 2020 is likely to be down by around 4.5%. Indeed, forecasts have been edging up over the last couple of months but what has become painfully apparent is the trade-off between economic growth and public health. The easing of lockdown restrictions is leading to an increase in infections, localised lockdowns are necessary and we are battling the onset of a second wave in the developed world at a time when parts of the emerging world are still seeing increasing rates of infection and deaths. There will be no return to anything like a normal growth cycle until a vaccine is produced in sufficient quantities for inoculation beyond just key workers and the vulnerable, or else an extremely unlikely sea-change in government policy and global adoption of ‘herd immunity’.

I’m a broken record in pointing out the folly of taking misplaced comfort in forecasts which are almost certainly going to be wrong  The Q2 data was ‘the worst ever’ by any measurable standard but is already very old news and the market is sanguine about where we go from here  instead of paying attention to what the drivers of future growth, the Central Banks and Government, are saying and doing. For now, the vague consensus is a ‘Nike swoosh’ shaped recovery so let’s stick with that but in practice, the recovery will not have a single shape, many companies, indeed some whole industries, have thrived but others will disappear altogether. Thank you, as always, to Schroders for providing the current consensus forecast from the great and good.

Inflation….but just not yet?

There has been an important change of tack by the US Federal Reserve Bank who, fearful of Japanese style decades of deflation, will continue to target an inflation rate of 2% but will now tolerate periods when it is above this level (i.e. they will not raise interest rates) to compensate for periods as now when it is well below. This signals that interest rates will stay lower for even longer. Fed head honcho Jerome Powell has said that Fed Funds will remain at zero till at least the end of 2023 which paves the way for similar rhetoric in Europe and the UK. On balance, this is good news for equities and other risk assets, less so for cash and bonds but only at the margin given that 2% inflation and a stronger growth environment is still a long way off. Nevertheless, it’s a strong message to the financial markets that Central Banks will continue to be very supportive of growth and will tolerate even higher levels of debt. Powell is effectively saying fill your boots, borrow now because rates are staying super low and inflation will reduce the debt in real terms when you pay it back.

In the nearer term, we continue to believe that the major problem for the global economy is currently deflation, not inflation, but that the change in stance by the Fed certainly increases the potential for inflation being significantly higher at some point down the track. We have taken cautionary first steps in building inflation protection into portfolios, noting our long-held ‘safe haven’ Trojan and Ruffer funds in our lower risk/reward Model Portfolios both have substantial positions in gold and in US and UK index-linked bonds and the introduction of Blackrock Gold & General in our higher risk mandates. We remain vigilant rather than concerned, noting that the economic handbook pointed to an inflationary outcome from central bank expansion post the global financial crisis. We think this time is different to the extent that previous episodes of QE led to an inflation in asset prices, whereas significant fiscal stimulus is directing money into the real economy and could be an inflationary force.

The Public Purse

The UK national debt soared past £2trn (and over 100% of national income) for the first time in August provoking fulmination in the media, much of it rather sensationalist and ill-informed. Our great-grandchildren will probably not be living on a diet of leaves and water to pay it off. I discussed the topic in an iWire a few months ago so will not risk boring you on this twice, save to point out the key issue, namely that it is the ability to service the debt on an ongoing basis that is more important in the medium term than the actual size of the government debt itself.

This massive debt and equally scary budget deficit (the annual difference between government expenditure and income and hence the amount the government borrows to balance the books) is manageable because the cost of servicing the debt is actually falling because bond yields are so low. There are still willing buyers of Gilts because safe-haven assets remain in demand and all other countries and their bond markets are in the same boat. More significantly there is an ‘uneconomic buyer’ with shedloads of Gilts being bought by the Bank of England through its QE programme. In effect, the Bank of England is using monetary policy to fund the fiscal policy that is keeping us all afloat. The concept of the Bank of England buying bonds in the market that have been newly issued by the UK Treasury’s Debt Management Office does seem a strange and uncomfortable one, the sort of convenient financial balancing act that works very well until it doesn’t, at which point plates are smashed all over the floor.

Reducing debt is not the Government’s primary focus which instead is to drive growth. Rishi flew a bit of a kite in the press about raising taxation for the wealthy but that went down like the proverbial lead balloon and no way will Boris countenance any austerity for the masses/voters. Several years of high borrowing can be easily supported by QE and very low interest rates with the national debt plateauing at over 100% of GDP quite comfortably. The ‘hopeful’ scenario is that we will grow our way out of this debt. If in time the wobbly tricycle of total public debt, the annual budget deficit and the cost of serving that deficit looks like it is going to fall over then some very difficult political decisions about taxation and public spending will then have to be faced.

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