Pandemic consequences on the economy
As we review the note from our last investment letter of April 2020 it is quite remarkable to think about what has happened over this period of time and how both policy makers and markets have responded to the Covid 19 induced crisis.
From a macro perspective, as we (hopefully) approach the peak infection rate in the UK and around the world it’s clear that policy makers underestimated the contagion factor of COVID 19 and it would appear that some view China as having misled the WHO which has led to a delayed response to the pandemic. This will be a point of contention for years to come and Trump has latched onto this factor in an attempt to deflect his own shortcomings. Therefore, tension between China and the G7 should be a consideration.
As we observe this situation unfold along with the concerted central bank efforts to stabilise asset prices it would seem the damaging consequences of the pandemic, from an economic perspective, will lead to deeper recessions than initially anticipated. The majority of observers have abandoned hopes for a V shaped recovery, and most are now expecting it to be U shaped.
As we can observe crude oil markets deal with minimal demand and storage at near capacity, we can also observer the rally in the technology giants who are seen as the ultimate winners in the current climate. However, we sense this would be an over-reaction and some longer-term thinking may be required. The assumption that some form of strong recovery is around the corner is a mistake in our view and the velocity of unemployment growth is yet to be full understood. One should always remember that consumption is circa 66% of GDP within a developed economy which means the travel and leisure sectors will be a long way from previous levels for a number of years when linked to unemployment and social distancing.
With this in mind it would also seem right to be cautious on the luxury goods sector as they are hit with downward pressure on revenue with very little flex in the cost base. This also links to a broader question around commercial and residential property, which will be viewed though a very different lens going forward.
As central banks balance sheets explode so too will domestic banks as they provide “shock absorbers” to the collapse in economic activity. However, it is difficult to see they have the capacity for the flood of defaults in the pipeline, which should be a concern for both investors and rating agencies.
One of the themes that seem worthy of further analysis is where, if any inflation will appear as this gigantic amount of liquidity floods the market. It is our view that food price inflation will be the theme which deserves more attention and one that will cause more pain for the lower end of the economic scale.
One final thought is that the Chancellor should abolish housing stamp tax for 12 months to encourage some economic activity. This would have the benefit of both the multiplier effect for the domestic economy and the feel-good factor through what is undoubtedly going to be a very difficult period indeed.
John White is the Founder of Calibrate Law. This is an extract from a note to investors from April 2020 and has been reproduced as a post for clients and other interested parties. It is not to be relied upon as a substitue for professional advice. No responsibility can be accepted by us for loss occasioned to any person acting or refraining from acting as a result of any material in these publications.