Economic Commentary January 2021


In 1968 Stanley Kubrick produced and directed; 2001 A Space Odyssey.  Remembered for adding a new dimension on to the Science Fiction Drama and the ever-present maleficent Hal 9000 - the autonomous Ai with a human personality.  But what is often missed from the film, was Kubrick’s imagining of the future; a world where politics and religion were cast aside for the greater good of humankind, and setting off to Jupiter to research a monolith, identical to the one discovered on earth.

Near 12 months to the day that the first patient was diagnosed with Coronavirus, and little was known about the disease, or the devastating scarring it would be leave on society.  Yet within a year, world governments, scientists and health agencies have combined their resources, their brainpower and invested billions in helping biotech companies develop a cure and show the world some light at the end of the long tunnel 2020 has been. 

Coronavirus still has not gone away, and there will be difficult times ahead to come, but we are now looking at 2021 with much more optimism than just a few months ago.  As the vaccine gets rolled out to more and more people, slowly we will move back to something that looks like normal.  The question we are finding ourselves asking, is what does the new normal look like? 

The positives we should not forget; changing the way we work, changing the way we travel, taking more local perspective on life, and looking out for and helping our community.  But at the same time, being able to once again socialise with family and friends.

But all is not rosy, and there are difficulties the UK and the World are going to face in 2021 and beyond.

  • Unemployment

The UK is looking at a double hit to unemployment levels, which will give the UK government a challenge to deal with.  Firstly, there is likely to be weak demand associated with the virus fears, and people still reluctant to spend.  The recovery hinges on consumer spending – will household confidence pick up and can it drive spending? 

Compounding the effects of COVID-19, will be Brexit.  There is a free trade agreement now in place, but it comes with increased administration.  The costs of new customs processes will put pressure on industries so far not affected by the pandemic and those which are already struggling will take a double hit.

  • Rolling back government support

How will the government roll back the unprecedented levels of support it offered the economy in 2020?  The furlough scheme, intended to wind down in November has been extended to March, and further extensions are possible depending on the rollout of the vaccine and future lockdowns.  There are potentially 2 million1 jobs at risk, many of these jobs were in sectors that were never allowed to fully reopen after the first lockdown (e.g. hospitality).  If social distancing rules are still a feature of 2021, then we could potentially see unemployment rise as the businesses change their models.

(1 Office of Budget Responsibility – Economic and Fiscal Outlook – November 2020)

A question for a later date, perhaps even as soon as the March 2021 budget, is how are the government going to recoup their spending?  We are expecting changes to tax and spending rules from the Treasury at some point in the future, but for now we are not prepared to speculate.

  • Negative interest rates

The debate within the Bank of England has been ongoing whether they should reduce rates perhaps even adopting negative rates.  However, it is more likely they will continue with printing more money, than going down this route.

  • The Climate challenges

As we have discussed in previous economic commentaries, the climate issues remain with us and this will also need massive government intervention and private capital to provide the solutions to stop global temperatures rising to unsustainable levels.

These challenges are not unique to the UK, as world governments are grappling with the same issues.  In the United States for example, they have a new President and although he has control of both the Senate and the House of Representatives, the margins are thin and getting dramatic changes through the Houses will be a challenge.

Looking to 2021 and beyond, we are now likely in an early post-recession phase globally, which implies an extended period of low inflation and low interest rates – this favours equities over bonds.  The immediate risks are markets are pricing in sentiment to the vaccine, and any negative news surrounding it is likely to hit global markets.  Further lockdowns in the US or Europe in early 2021 (at the same time as government support unwinding) would likely cause those businesses already struggling to fold.

Looking closer to home, and how we have seen our portfolios develop over the last 12 months, and where our strategies have worked (or not!)

As you know, we have taken the view over the long-term, that our clients love to see values increase in their portfolios.  That is a given.  But for the most part, they hate seeing losses more – that too is natural!

Our philosophy, particularly for the more cautious and moderate clients, is to design portfolios that attempt to fall less than the markets when they go backwards, and typically this is done by “missing” out on some of the top edge of the growth in buoyant markets.

Looking back over the last 12 years since the financial crisis, there have been very minimal threats to the global economy and markets to test this theory.  In 2020, with the pandemic setting in and despite markets becoming very volatile, most of our clients will have seen no losses, and in a lot of cases gains over the last 12 months. And, in terms of investment performance at least, 2021 has started well.

All the decisions we make require risk; doing “nothing” can be as equally risky as doing “something” over the long term.  To try and beat the long-term growth expectations we must take measured risks that the typical market benchmark will avoid – and over the last 5 years we have done this on occasion and it has generally served our clients well:

  • Favoring allocations to UK Smaller Companies – companies that are not located in the FTSE 100 or 250 index but where there is still daily trading and liquidity. The opportunities for growth are significant but, in doing so, we increase volatility in the portfolio.
  • We have for some time preferred to lend to Infrastructure Projects, rather than the typical lending to UK governments or corporations.
  • We prefer to hold equity in infrastructure projects rather than owning commercial retail or office property.
  • Diversifying global equity away from mainstream MSCI World companies, to smaller niche industries such as Robotics, Cyber, Water and Battery Storage.

And of course, we have in hindsight made mistakes!

  • We have been for some time concerned with the effects of rising interest rates on Government and Corporate Debt, to combat and hedge against this risk, we included fixed interest securities that would benefit from rising interest rates.  2020 reversed any potential interest rate rises (and indeed we have seen them cut further) and the likelihood of a reversion to normal rates has now been kicked into the long grass – and this has impacted on values accordingly.

Looking towards 2021, we will be making tactical alterations to our asset allocation.  Whereas in 2020 we were neutral across the board, we have elected to reduce the weightings to some asset classes and increase the weighting to others.  GFP offers five weighting categories starting at ‘lowest’ then through ‘low’, ‘neutral’, ‘high’ and finally ‘highest’.

 

Cash

Our 2020 position was to remain neutral in cash.  Pre pandemic global economies were starting to power on, and whilst the prospect of interest rate rises was still far off, they were appearing on the horizon.  Coronavirus and the global response have kicked this decision into the long grass.  Central Banks have cut interest rates across the world, and closer to home we have recently seen National Savings cut their flagship product, the Income Bond, from 1.16% to 0.01%2 - the market is not looking for retail money.

(2 National Savings Income Bonds)

In addition, whilst the long-term inflation rates remain low, we are expecting spikes in 2021, as the virus starts to be vaccinated against; global aviation and travel resumes, commodity prices recover and pressures on wage growth (government intervention to combat unemployment).

We are therefore looking to reduce cash holdings in our asset allocation model, and move towards growth assets, which are likely to protect against inflation.

However, cash remains a useful tool in protecting against short term market volatility, and we reiterate our advice from 2020:

  • Ensure a sufficient emergency fund is kept.
  • Clearing debt and reducing interest payments is a form of saving.

Verdict – Reduce from Neutral to Low

 

Loans and Debt

We are expecting Central Banks to continue to be loose with their policies over the next 12 months, helping governments fund borrowing, to ease the economic damage of restrictions.  It is unlikely that rates will rise anytime soon because governments will want to keep the costs of servicing debt at or close to zero.  Additionally, Central Banks may come under political pressure into financing ambitious fiscal programs.  With these inflationary pressures, there is a risk that Central Banks may be too late to respond (even if they want to respond) to rising inflation.

Ultimately, this is bringing forward future government spending, but the debt will remain sustainable at current interest rates, and therefore we will look to make some changes to this space.  With the prospect of interest rate rises now subdued, we will be looking to move to low position in the Loans and Debt space and reduce the weightings to floating rate notes and ground rents, we think there will be opportunities elsewhere in a low interest environment.

Verdict – Reduce from Neutral to Low

 

Property

2020 has been a difficult year for Commercial Property, as many of our clients will have experienced, with commercial property managers having to suspend trading on their funds, due to unsecure valuations.  The regulator is looking to step in to provide investors and fund managers a fair chance when it comes to liquidity in illiquid assets.  We are expecting at some point in 2021, property funds with illiquid assets being unable to offer daily liquidity and move to a longer deal flow, and this seems perfectly sensible to us as it reflects the timeframe a fund manager would need to sell a property to meet investor redemptions.

On the back of this regulatory change, and the problems that illiquidity causes, we have amended the property sub-allocation to focus primarily on two areas:

  • UK Commercial Property that will be in demand for the next 20 years, not the last 20.
  • UK and Global Infrastructure Projects

In conversations with clients, we found that liquidity is more important than volatility in this space.

Following a Keynesian Economic approach, we would expect world governments to initially increase expenditure to stimulate demand and pull economies out of recession, and one route typically governments follow is by bringing forward infrastructure projects from the future.  We are expecting government expenditure to flow into this space.  Several world leaders have mirrored Roosevelt’s “New Deal” with the 2020 version of a “Green New Deal” to build and develop sustainable infrastructure projects for decades to come.

Verdict – Reduce from Neutral to Low

 

Mixed

The mixed strategies in play throughout 2019 and 2020 have proved their worth, with a split strategy capturing most of the upside during the peaks of 2019 and providing downside protections when markets became very volatile in March 2020.

We will be giving these fund managers an increased mandate in 2021, to help navigate through the likely choppy waters in Q1 & Q2 2021 and hopefully to the recovery in late 2021, when the vaccine rollout is in full swing.

Verdict – Increase from Neutral to High

 

UK Equity

Compared to other developed world economies, UK equities have still not returned to pre 2020 levels.  This is not to be unexpected, the UK economy and largest companies on the London Stock exchange are dominated by services, aviation, and oil, all of which have struggled during the pandemic and are not likely to return to normal levels until 2021/22.

However, the UK economy is still forecast to grow circa 7-8% in 2021 and this should be positive for UK equity markets.  We will be backing active fund managers to spot the recovering companies and look to capitalise on lower prices. Indeed, the first weeks of 2021 bear out this philosophy.

Verdict – Increase from Neutral to High

 

Overseas Equities

Most of developed world equities and the diversifier themes shrugged off the bear market in March 2020 and delivered spectacular returns year to date.  As the world recovers from Coronavirus, we expect global equities to continue to perform, and governments and central banks will create an environment for them to do so.  China has performed an almost perfect V recovery3 , as they were able to deal with the pandemic before it became widespread, and there is also potential for the US economy to mimic China in 2021.

(3 – Reuters)

We expect some of the growth in the developed world to be driven by Environmental, Social & Governance (ESG) factors, with the world now discussing more seriously climate threats, “building back better”.

With the dollar weaker, and debt relatively cheap, we also expect Emerging Markets to do well, if there is global support to help rollout the vaccine to these countries.  It is also likely that commodities will perform well, as countries begin to rebuild, and aviation returns to normal levels. The demand for assets such as oil will likely outpace supply, which should also be a benefit for the oil rich emerging market countries.

The “themes” of Robotics, Cyber Security, Water and Battery Storage have dominated returns in this space over the last 12 months, as these companies are at the fore front of the recovery, and we expect them to continue to perform during 2021 and we are not looking to make changes in this space yet.

 

Verdict – Increase Neutral to High

This article has been written for information purposes only and does not represent personalised advice.

The value of investments can fall as well as rise and are not guaranteed.

Past Performance is not a guide to future performance.






Article published: 18/01/2021

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