The vaccination roll-out appears to be providing some breathing space for markets and society as a whole in countries that have been able to achieve a fairly high level of coverage. Spring is in the air and economies are actually or thinking about re-opening. People are hoping to do things other than sitting in front of a screen for hours on end. The burst of life will boost economic growth. Investors are expecting strong data and markets are pricing it in. Now it is a case of watching to see if the data confirms what we all expect. If so, recovery will strengthen, equities should continue to perform but the strains of the reflation trade will re-emerge. Beyond the recovery, sustainability will be at the centre of the next cycle.
Spring is sprung
My last note was quite bullish, noting the strength of investor optimism about the economic outlook in the wake of more and more of the world’s population receiving vaccinations against COVID-19. Not a lot has changed in the last two weeks although I would note that the vaccination roll-out and the subsequent decline in the intensity of the pandemic is clearly uneven across countries. The shocking numbers from Brazil and India contrast vividly with the progress made in countries like the US and the UK. This should provide some caution about the global outlook. If big emerging economies continue to struggle, that will be a drag on global growth. Moreover, the high level of infection rates in those countries will delay a full return to normalised international travel, which is clearly a negative for sectors such as airlines and hotels. Nevertheless, markets continue to trade on optimism and the recent increase in long-term US bond yields has not derailed the rally. There has also been encouraging news from Europe with a number of countries reporting an acceleration in the vaccine roll-out.
I am optimistic in the short-term. April is traditionally a very strong month for global equities. For a number of key equity indices, over the last 15-years, April has been the best performing month of the year. This year looks like being no different as US markets have got off to a strong start, with the S&P 500 making new all-time highs. Also the bond market has stabilised. This has allowed a resurgence of relative performance from technology stocks and growth in general. Central banks have stabilised expectations about changes to monetary policy and its hard, in the short term at least, to see a huge amount of new “short” positions in Treasuries or fixed income in general. That’s not to say yields won’t eventually go higher, but it was never going to be a straight line move. At the moment, markets are generally back to being driven by the very powerful combination of good economic data and super-easy monetary policy.
Show us the data
For the coming weeks it will be all about the data. The consensus’ stall has been set out – inflation will pick up because of base effects and other temporary factors, growth will be strong as re-openings occur, and economists will be trying to judge how quickly output gaps can be closed. The US will be at the forefront given the combination of vaccinations and stimulus. In the minutes of the last Federal Reserve (Fed) open markets committee, the US central bank again stated that policy will be left on hold until its inflation and employment targets have been met. Let’s say the unemployment level reached before the COVID-19 crisis (3.5%) represented a full employment situation. In March, the unemployment rate was 6.0%. In the last cycle it took five and a half years to get the unemployment rate down from 6% to 3.5%. It will clearly be quicker this time given the rapid re-opening of many parts of the economy. At the pace of decline in the unemployment rate registered so far in 2021, the economy will be close to full employment by the middle of next summer – ahead of the date that the Fed itself has pencilled in for raising interest rates. However, sustaining the “recovery” pace of declines in the unemployment rate might be difficult, depending in the extent that permanent damage has been done to some sectors and jobs in them.
It will also be interesting to see how labour markets develop in coming years. The pandemic has accelerated the move towards flexible working in many parts of the services sector. Working from home will be a more permanent phenomena for many of us, even if it is mixed with spending some time in the office. There will be changes to the relationship between employers and employees and the kinds of benefits that will be offered and demanded as a result. Retaining employees and getting the most out of them will be more nuanced in the future than simply offering pay rises, season ticket loans and subsidised gym membership. What about more flexibility in working hours? What about financial assistance in kitting out the home office? What about more sensitivity around the kind of medical benefits offered, especially around social care and mental health? Of course, ultimately the cost of labour is dependent on supply and demand and some kind of Phillips Curve relationship will still exist. But the cost may not be simply higher wages in order to hire and attract. As a result, the relationship between employment, wages and inflation could continue to be very difficult to understand and model. More flexibility in the labour force usually means less upward pressure on wages. However, the cost of employment may still impact on margins and prices.
The pandemic, with the related lockdowns, is bound to have a lasting impact on the relationship people have with work, both at the individual and aggregate level. It sounds “corny” but the last year has shown that there is more to life than “earning a crust”. People have missed out on social interaction, on being with friends and family and on experiences outside of the home. They will value them more as a result and the trade-off between enjoying those things and a salaried income is likely to have changed. Companies will need to respond to that and from a responsible investing point of view, more care will be need to be taken in understanding how companies manage their human capital, how they act to address diversity and inclusion and how they ensure that people want to work for them in a productive way. The “S” in ESG will become more important and employers will have to think about doing more than having a rainbow incorporated into their corporate logo once a year. I get the sense that people that have been lucky enough to have been in continuous employment over the last year will emerge from this crisis thinking “I had to give up more or less everything other than work”. They are likely to see that as being a major credit in their account with their employers.
Beyond the recovery
There is a lot to think about how the rest of this decade will evolve. Since the turn of the century we have had three big “busts” – the original technology bust at the beginning of the new millennium, the global financial crisis of 2008, and the recent COVID-19 shutdown. Accompanying the economic developments, inequality has worsened, and the biosphere has become more damaged. Nativism and populism have increasingly dominated the political agenda – even seen with vaccines. So is the recovery from COVID a chance to reset things? The recent evidence of excessive greed-driven risk-taking in financial markets doesn’t sit well with a zeitgeist that is more “woke” – and I mean that in the most positive way. Care for the planet and people is increasingly at the heart of an emerging political and business agenda. The next cycle of economic growth should be driven by factors that are common to all our well-being, not just individual wealth accretion. Climate change mitigation, further digitalisation, extension of accessible healthcare provision to needy communities are the themes that should be at the centre of the next cycle. The attention to these themes needs to be nurtured and prioritised over simple red-meat capitalist growth because another big boom-bust could have dire political and ecological consequences.
Focus on sustainability
Pretty soon we will have recovered from the coronavirus crisis. There will be less need for emergency monetary and fiscal support. Yet the need to tackle climate change and inequality will also require broad policy support. I can’t see central banks being in a position to fully withdraw from activities that keep interest rates low, especially if the one thing that is a constraint on the new monetary normality – inflation – remains under control. The monetary authorities do have a job to do in “normalising”, but they can take their time. Central banks have also become more “woke” and their activities going forward will not just simply be buying bonds and setting the overnight rate. The assets they do buy, the development of digital currencies and the assessment of more social factors in the economic environment can all make contributions to a fairer and more inclusive society. They also need to be tough. The world does not need over-leveraged wannabe “Masters of the Universe” nor the institutions that facilitate the kind of behaviour that can create volatility in markets, wealth loss and the misallocation of resources.
I get the sense that markets and society in general is taking a bit of a breather, at least in parts of the world that can. There are few big political focus points like there have been in recent years (Brexit deadlines, US elections) and the lifting of social restrictions will mean holidays and time spent away from the screen. A period of calm is already reflected in the VIX index getting back to its pre-crisis lows. The next few weeks will be a period of confirmation that the recovery is happening. If they are, then the shape of the world going forward will be the focus of investors. Sure, the impact of pent-up consumer spending and business investment should continue beyond the end of this year, as will more generous fiscal policies. However, at some point the marginal impact of these will ease and new factors will become important for investors. In the last year a lot of mental effort was spent on thinking what a post-COVID world would look like. Soon it will be time to start experiencing that – smart working, greater care of social factors in business and public life and an acceleration of de-carbonisation. If we are lucky and smart, a sustained and greener economic expansion might be ahead of us.
Best in class
I enjoyed the European football games this week. The Bayern Munich versus PSG one was a bit of a classic, played out in a Bavarian snowstorm. The semi-final line up in the Champions League will be very strong with some exciting potential combinations, including a potential final between Real Madrid and Bayern Munich, two of the most decorated Champions League winners. But we could also see a semi-final between two of the richest clubs in the world – Man City and PSG. Tantalising stuff. In the less glamourous competition, Manchester United are on track to a semi-final date hosting either Ajax or Roma. Manchester could be the city of European football come May!
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