Reasons to be cheerful…
“Reasons to be cheerful, one, two, three...Yes, yes, dear, dear...Perhaps next year...Or maybe even now...In which case.” – Ian Dury & The Blockheads.
It was the eve of the US Presidential Election (and was it really just 3 weeks ago?) when I suggested to my colleagues that I would write my next letter basing it upon the 1970s Ian Dury and the Blockheads song "Reasons to be Cheerful, Pt. 3". Perhaps, it would be fairer to entitle this "View from the desk" as "reasons to be optimistic in 2021" but that's not what Mr Dury wrote and sang....
Little did I suspect then that we would be cheered by the announcement of 3 very promising and, according to the science, highly effective vaccines against coronavirus by the time I wrote this missive. We have seen the first results (with a sigh of relief) of successful phase 3 testing of COVID‐19 vaccines. This is a very welcome dose of good news during a period that has recently seen a spike in the number of infection cases in Europe and the US. There must be every hope that these will act as the proverbial game‐changers to restore life back towards some sort of "new normal" in 2021.
The US presidential election (again with a sigh of relief) is now over. The Republican elephant in the room seems to be resolved as President Trump has finally accepted defeat and President‐Elect Joe Biden and his team are now preparing to take office at the start of 2021. Although we shall not know for sure until January, the Senate will most probably remain in Republican hands. This brings considerable comfort to the financial markets that feared major tax hikes and more government interference in the nation’s economic affairs. I have even seen it suggested that Mr Biden himself will not be too disappointed that the much predicted “blue wave” of Democratic Party electoral success did not come crashing on the shore as it will mean he is able to follow the more conciliatory, middle‐ground agenda that he will be most comfortable with, rather than the radical agenda the left wing of his party were looking for.
Post the vaccine announcements, and despite having spent the best part of my 27 years in the industry being a self‐ confessed stock market pessimist (and often being in a gang of one), I find myself in the unusual (and I must admit a shade uncomfortable) position of being somewhat optimistic, even “cheerful” when I look at markets today and where I believe they might go.
Overall, economic news has been generally much better than expected. The US stock market, which continues to be the global engine, is brimming with optimism, reaching record highs. Governments will continue to promote programs to stimulate economic growth. Central banks will continue to pursue supportive monetary policies. To be fair, they really have little choice at this stage with echoed promises of doing whatever it takes to protect their economies. With developed‐world interest rates across the globe at effectively zero, and even negative in places, what alternative to cash savings does an investor have apart from equities and bonds?
Of course, stock market investment is never plain sailing, and you should not be surprised that this positive broader outlook is accompanied by an expectation of some volatility along the way, particularly if concerns about re‐opening economies persist. However, I feel that being overly pessimistic about equities now would be akin to betting against medicine, science, human ingenuity, and the direction of monetary policy. If I were a betting man (who am I kidding, I “am” a betting man at least when it comes to the horses) then I am pretty sure I know on which side of this bet I should like to be.
Bear markets typically foreshadow economic recessions, rather than persist through the early and middle stages of the recovery. In the US, there have been six instances since 1930 when stocks experienced market declines of greater than 30%. In every instance, stocks were meaningfully higher 1 and 3 years after the trough, the inevitable volatility and market corrections along the way notwithstanding.
This time, global stocks experienced a full‐blown recessionary bear market in roughly twenty trading days in March and early April. The market trough, as is typically the case, coincided with extreme volatility, lop‐sided investor positioning, and dire sentiment globally. By early May, investors had largely capitulated with trillions of dollars seeking the relative safety of government bonds and cash‐like assets. However, policy responses emerged, and financial conditions eased.
Global equity valuations, although not necessarily cheap on an absolute basis, remain attractive to many alternative homes for our savings. As already mentioned, with the discount (interest) rates used to determine the present value of future cash flows near zero in much of the developed world, this is highly suggestive that investors will likely be willing to pay higher multiples of earnings over time.
Equity investors should, however, be mindful of the types of businesses they want to own for the long term. Market leadership will likely come down to which businesses are the disruptors and which businesses are being disrupted.
The high‐flying winners in this market are disrupting the way the economy, business, and society operates. We may end up paying higher prices/valuations for shares in these businesses than for the broader market, but we can also expect their earnings to grow faster than the broader market. That is the theory anyway.
We must also be careful to avoid short‐term “noise”. When Pfizer announced that the first potential vaccine would need to be stored at ‐70 degrees Celsius there was a clamour to seek companies that provided sector leadership in refrigeration equipment. German cold storage company Va‐Q‐Tec saw its share price rise from 32 euros per share to 53 in a matter of days, only for Moderna’s announcement of a vaccine that could be stored at room temperature a week later. The shares almost instantly fell back by over 20% but have now stabilised at a price higher than they were ahead of Pfizer’s announcement (c45 euros as I write this). Initial over‐excitement has given way to a realisation that the company’s passive containers that use dry ice to maintain ultra‐cold temperatures will still have an increased demand – just not quite as much as there would have been had Pfizer’s vaccine been the only option.
In the UK, Rishi Sunak will have announced his spending plans by the time you read this, and there is no doubt that on top of huge programmes already announced in the UK with regards to increased Defence spending and an understandably ambitious Green Infrastructure package, the government’s desire to “build back better” is tangible. Inevitably, increased taxation will be necessary to help pay for both this and the debt we have had to accrue to fund the battle against coronavirus. However, it is long‐term growth that is our greatest ally here and I have optimism that the Chancellor understands and appreciates this.
Investment opportunities are also available far and wide. We have seen robust economic news from Asia which is starting to do well again as economies “re‐open”, even ahead of vaccines. Sales of luxury goods are strong and even car sales have picked up. The Regional Comprehensive Economic Partnership (RCEP) was recently signed by 15 countries including China, Japan, South Korea, Australia and New Zealand. RCEP is expected to eliminate a range of tariffs on imports within 20 years and includes harmonized “rules of origin” policies which sets out how much regional content a product must have to enjoy lower tariffs. We continue to see the Far East as a core investment theme in the years ahead.
What of Europe and the dreaded word that must not be spoken. Brexit looms ever larger for us although in global terms I fear it is little more than a “minor local economic scuffle” as a leading US economist said last week. Anecdotally from speaking to clients and friends who are most directly affected in their businesses by the implications of the 2016 vote, I suspect most of us are really not aware of the amount of unseen preparatory work that is having to take place. That this is based upon uncertain scenarios for how our relationship with Europe will look post 31st December is more than a shade unfair. However, one has to believe that by the end of this year the uncertainty around Brexit will have been removed (and I think it is fair to say that a ‘no deal’ outcome has lost its propensity to shock now) one way or the other.
In a previous “View from the desk” I discussed the long‐term threat to the vibrancy of town and city centres that Coronavirus had brought, citing the closure of Pret‐A‐Manger food outlets as a symbolic gauge of this. However, the encouraging breakthroughs in the race to find a jab that gives protection against Covid‐19 has raised hopes, and provided a reason for optimism, that commuters and tourists will soon start returning in large numbers to such city centres for the first time since March. Understandably, the government is attempting to dampen some expectations as to how quickly a fully‐fledged vaccine programme (largely focused on the Oxford/Astra Zeneca version in the UK) can be rolled out. However, having spent a couple of days a week in the London office between Lockdowns I and II, it would be great to see the end of the “ghost town” versions of the West End and the City.
A study from consultant Arup suggests that a best case scenario, in which office workers feel confident enough to work four days a week at their desks within a year, will generate an extra £41 billion in economic output and help save 57,000 jobs in hospitality, retail and entertainment. In a slightly more cautious projection, in which the average time spent in the office is three days a week, the benefit is estimated at £22 billion and 31,000 jobs. Business leaders are desperate for the lifeblood of office workers and visitors to surge back after eight months of deserted streets, empty restaurants, and closed theatres. There is, surely, light at the end of this tunnel now and another reason to be cheerful?
It is fully justified that people should be optimistic in looking forward to robust stock market growth in 2021. However, there are other things we can, hopefully, plan for too. During a recent presentation by a former Rathbones colleague of mine that I know well, and who has been in the industry even longer than me, I heard him tell the audience “I am looking forward to going shopping”. If you knew this chap you would have been as stunned as I was, but in essence his point was a sensible one. He currently works from home at his desk and even does his shopping at his desk. It is the physical act of getting out and about as much as anything else that he is craving for.
I can certainly empathise with this, as I am sure most of you can too. For me, it is not retail therapy that I am missing but it is the thunder of hooves and excited roars of the crowd at a day’s horse racing; or the emotions and cut and thrust of attending a rugby match, or the contented hum of a crowd at languid day’s test match cricket. These are all things, I think it is fair to say, we will never take for granted again. We might be face‐masked for now, but the vaccine breakthroughs bring genuine grounds for optimism and the pleasure we derive from such events can be even greater than it was before. We all need things to look forward to in life – it is what makes it worth living ‐ and the prospect of attending such events before too long (or even going shopping freely if that is what tickles your fancy) is surely another reason to be cheerful.
Graham Withers – Head of Discretionary Investment Management November 24th, 2020