Jonathan Marriott, Chief Investment Officer
In March, the pandemic led to a liquidity crisis with almost all asset classes selling off as investors scrambled for liquidity. Credit spreads ballooned outwards, government bonds sold off and equity markets collapsed. Since then, we have seen colossal monetary and fiscal actions to support the global economy from the impact of the pandemic. The increased spending has been funded by ballooning government debt issuance.
The furlough scheme has kept people off the unemployment register in this country and in the US the Coronavirus Aid, Relief, and Economic Security (CARES) Act has resulted in some lower paid workers better off financially not working than they were before. In the UK, the furlough scheme unwinds between August and October and many people may find they have no job to return to. Rishi Sunak took action last week to counter this, but it seems inevitable that unemployment will rise as the furlough scheme is removed. In the US, the Paycheck Protection Program ends at the end of the month, and any further scheme is likely to be less generous.
While some areas have been hit particularly hard, such as hospitality, travel and tourism; there are signs that retail spending as a whole has held up better than expected. US retail sales numbers for May and June show a sharp recovery from the drop in March and April. JP Morgan this week announced that credit card spending was nearly at the same level as last year. They also said that delinquency rates were low but also made huge loan loss provisions reflecting a cautious outlook. US politicians are debating the next rescue package to keep the economy going. These economic packages are welcome while pandemic restrictions are in place but for some businesses they may just be delaying the inevitable collapse. Governments around the word are borrowing huge amounts to keep their economies alive while the pandemic continues, but how will this be paid for?
At present, central banks are providing ample liquidity buying up bonds and expanding their balance sheets. Governments have to pay their debts and to do this they need to increase tax revenue. This can be achieved by raising taxes, inflation or growing the economy. Raising taxes in an economic slowdown may only makes things worse, but with a review of Capital Gains Tax on the cards, this may be something the UK government is looking at. The outlook for inflation is complex. Some businesses may be forced to push the costs of the pandemic onto customers. For example, pubs with restricted numbers may raise prices to compensate for the reduced number of customers; however, this may be only temporary. As unemployment rises post the furlough scheme, demand may fall further, thus reducing inflationary pressures. Technological and demographic factors that have kept inflation low over the last ten years have not gone away either. Pumping money can depress the currency leading to inflation but if everyone is doing that at the same time, this will not work. In the end, the best way to repay government debt is to grow the economy. Investment in infrastructure and housing may help on this front, or as Boris Johnson put it "Build, Build, Build".
If governments around the world come to a similar conclusion, we can expect low interest rates and increased government investment to persist for a long period after the pandemic is over. This is should be encouraging for equity investors. However, the pandemic has also accentuated trends in society that were in place before the pandemic. The trend to online shopping has accelerated and is not likely to reverse. Businesses that can benefit from this will continue to flourish whilst others will fail. Thus, a selective approach will remain important.
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