Kevin von Neuschatz, Group CEO at Stanhope Financial, explains how the post-pandemic recovery of SMEs can be expedited.
When the full extent of the pandemic was first revealed, governments around the world offered generous loan and furlough support schemes in an effort to keep companies afloat. Yet the fact remains that the majority of businesses will have lost customers, suppliers, and partners during this difficult period, and it will take time for things to return to normal.
Critical Support For SMEs
The pandemic also provided the big banks with the opportunity to offer critical support, and many did so. From mortgage protection plans to low-rate interest loans, there are numerous examples of large financial institutions doing their best to support the recovery. Yet the fact remains that for small and medium sized enterprises (SMEs) tier one banking services have remained out of reach for many years. This problem first arose during the 2008 financial crash, which triggered recessions in major economies around the world. Credit lines were pulled, due diligence, background checks and borrowing estimates revised, all making it harder for smaller firms to secure credit and finance.
The tidal wave of financial restrictions triggered by the 2008 crash also meant that many big banks withdrew their services from emerging or high-risk markets in an effort to reduce risk. The sad fact is that for many companies seeking access to high quality financial services, from payments to FX support, the banking infrastructure simply no longer exists anymore.
Throw in the chaos of the pandemic, with many businesses struggling to bounce back and the lack of support is profound and urgent. In the UK for example, there are around six million SMEs, which are a major source of employment and support for the wider national economy. Anyone who has ever founded a start-up business knows just how hard it is to attract investment. Many of these organisations are in the early stages of developing their product or service and it can take time to build a strong customer base and accelerate growth. These businesses would also benefit from new talent but paying sky high salaries is often a high-risk strategy when margins are tight.
The bottom line is that many of these companies need external financial support. Bank lending is the most common source of external finance for many SMEs and entrepreneurs, which tend to be reliant on traditional debt to fulfil their start-up dreams. While it is commonly used by small businesses, however, traditional bank finance poses challenges to SMEs, in particular to newer, innovative and fast-growing companies, with a higher risk-return profile.
The New Normal For SMEs
While bank financing will continue to be crucial for the SME sector, there is a broad concern that credit constraints will simply become “the new normal” for SMEs and entrepreneurs. It is therefore necessary to broaden the range of financing instruments available to SMEs and entrepreneurs, in order to enable them to continue to play their role in investment, growth, innovation and employment. It is now highly important for SMEs to provide credit as well as have legitimate loans, trading and payments support in the post-Covid climate. SMEs could try crowdfunding, or donations. In recent years, with the support of public programmes, it has become increasingly possible to offer hybrid tools to SMEs with lower credit ratings and smaller funding needs than what would be the practice in private capital markets.
Obtaining access to credit and payments support is critical for many businesses seeking to survive and thrive in a post-Covid economy. The time has come for tier one banking services to be accessible to companies of all sizes, and not just reserved for larger, more established companies. The answer is to work with specialist fintech providers that can combine speedy online services with actual consultancy and advice to ensure the best products are purchased and delivered.
For ambitious businesses keen to reboot following the devastation of the pandemic, the time for accessing tier one banking services is now.
The UK economy shrank by a record 9.9% last year but narrowly avoided a much-feared double-dip recession. The shrinking economy is thought to be largely due to coronavirus restrictions according to figures from the Office for National Statistics (ONS).
The latest report shows that the UK’s economic contraction was more than twice as much as the previous largest annual fall on record.
There was some good news even though the overall annual report looked bleak as the economy recovered to grow by 1.2% in December, after shrinking by 2.3% in November.
This is thought to be due to the relaxation of lockdowns during the run-up to Christmas, but many industries which had started to recover lost ground were hit again and suffered further losses such as automotive, hospitality, the beauty sector such as hairdressers.
The slight growth in December confirmed economists’ hope, that the UK economy looks set to avoid what could have been its first double-dip recession in over 40 years. However, with the lockdown currently in full force, there is some trepidation as to what the figures for January and February bring.
What is a Double-Dip Recession?
A recession is defined as a period of two consecutive months where a country’s economy shrinks. A double-dip recession is when the economy recovers for a short period of time into growth only to fall back into shrinkage once more.
Speaking about the news, Chancellor Rishi Sunak said: "Today's figures show that the economy has experienced a serious shock as a result of the pandemic, which has been felt by countries around the world.
"While there are some positive signs of the economy's resilience over the winter, we know that the current lockdown continues to have a significant impact on many people and businesses.
"That's why my focus remains fixed on doing everything we can to protect jobs, businesses and livelihoods."
Britain has suffered a torrid time during the coronavirus pandemic, as it reported Europe's highest death toll and also sits near the top of the world's highest death tolls per capita. This has led to long periods of lockdowns and continuous restrictions, which it seems have had a record-breaking negative impact on what was a thriving economy a year ago.
The blow suffered by the large service sector, on which the UK is very dependant, much of which has been closed for the best part of the last year has been cited by many as one of the largest contributing factors to the damage suffered by the UK economy.
However, there is hope with Britain boasting the highest vaccination rate of most European countries so far, raising the prospect of a faster overall rebound for its economy, although experts are cautioning that this may not occur until later this year.
We all know how difficult the COVID-19 pandemic has made things throughout the world. Nobody has been unaffected. Almost all industries have been dramatically impacted by the crisis, which has left millions of people out of work. While the beginning of 2021 looks to continue to be rough, with Q1 being another lost quarter for many industries, the rest of the year looks promising for a huge resurgence.
Nearly all industries should see a bounceback in 2021 from a massive 2020 falloff. However, we'll focus on six industries that seem poised for massive rebounds.
Construction
The construction industry was absolutely decimated by the pandemic. Many factors affected the drop in the industries stake during 2020. With industries across the board struggling, many planned expansions were halted. Instead, companies diverted funds to help stay afloat rather than grow. Many construction projects were abandoned, either temporarily or permanently.
In addition to the halted projects, few people were looking to start new projects. With so much uncertainty, even organizations that weren't brought to the brink weren't likely to attempt to grow. Client bases were likely to be greatly diminished to non-existent due to potential buyers being out of work.
Another reason for the lull in the construction industry was that with so many businesses closing, the few companies that were looking to expand were likely to move into a previously occupied space. While there might be some construction called for in these cases, the projects were far smaller and finished much quicker than building a new facility from the ground up would have been.
With a likely rebound in industries across the board beginning in spring of 2021, expect a fresh need for the construction industry to get back to work.
Live Events
Live events nearly came to a standstill in 2020. Outside of protests and political rallies, large gatherings and even small gatherings pretty much ceased to exist. Fortunately, this is one industry that should come back with a vengeance later in the year. People have been isolated from friends and family, they have been working from home, and they haven't been to a party in forever. When getting together is deemed safe, expect big gatherings.
This will have an impact on every aspect of the economy that gets a boom from live events. Venues will clearly win big with pretty much guaranteed full bookings and sold out events once things return to normalcy. Other industries like hospitality and transportation will see a big boom as out of towners come to these events. The big sporting corporations will obviously get a big boost from being able to sell seats at full capacity.
Event planners, large and small, will see their services in full demand. Whether planning small gatherings of a handful of people or festivals that attract thousands, all types of event planners will be needed. Insurance companies that sell event insurance will also see a boost as this type of insurance has largely gone unpurchased over the past year.
Social calendars will likely be packed full from late spring onward. Artists will crowd the road to return to performing live concerts. City halls will be packed with people who have been waiting to tie the knot. Whether family, friends, schools, or any other type of group, expect reunions aplenty. Employers hoping to raise employee morale after a very difficult year will plan all sorts of retreats and outings. There will be no shortage of events in 2021.
Hotels & Other Accommodations
People are going to want to travel again. The world is suffering from a near-universal case of cabin fever. The best solution for that is to get out of town. People will likely be traveling in record numbers once it is safe to do so. While many hotels and other accommodations were forced to shut their doors for good during the pandemic, those that make it through should find an abundance of riches on the other side.
With such a high demand for accommodation and a narrowed competition pool, hotels can expect many nights of turning away guests due to no availability. Those able to time things just right could find the perfect moment to enter the hospitality industry and turn a profit immediately.
Airlines & Other Transportation
As mentioned, people will be looking to travel once they can. Expect the skies to be full and freeways to be crowded. Between border closures, lockdowns, high unemployment rates, and countless restrictions to the kinds of things that people look for in a vacation, people have generally been staying put this last year. Nomads are becoming restless and will look to be on the move as soon as possible.
Bars & Restaurants
Food and drink service was one of the hardest-hit industries. However, bars and restaurants that managed to make it through the pandemic should be facing a new type of dilemma later in the year. Making sure they don't violate fire codes by being overcapacity.
Some restaurants were able to adjust to the pandemic well enough to keep from being hit too hard with takeout options. However, many restaurants simply aren't suited well enough to make it in the world of takeout. Restaurants relying heavily on their atmosphere for their appeal and fine dining venues had a difficult transition.
Bars in many parts of the country were completely helpless, with a takeout model not really a possibility for them.
While due to financial concerns, not everyone who wants to go traveling will have that option, most people will be able to start going out to a bar or restaurant again. Nearly everyone will be looking to hit the town.
Movie Theaters and Playhouses
Many theaters had to close down entirely for parts of 2020. Once able to fully reopen, movie theaters are going to have a lot to work with in pulling in big crowds as many big event movies have been sitting on the shelf awaiting a theatrical release rather than going straight to streaming. Movie theaters can expect a huge influx of top-grossing films to fill their seats on a daily basis in 2021.
A Welcome Return to Normalcy
These are far from all of the industries that were negatively affected by the last year. It has been tough all around. Fortunately, these industries are far from the only ones expected to have a nice recovery later this year. People can expect a general rebound of the economy all around. It may take a little while to get back to the levels the country was at pre-pandemic, but we can certainly expect a strong move in that direction.
Amid the economic shipwreck of COVID-19, there are already glimmers of entrepreneurial hope - with the number of start-ups continuing to grow. There were almost five thousand more company incorporations during the first full week of December, compared to the same week the previous year. It’s likely that thousands of workers who have seen their professional lives put on hold are now using this as an opportunity to branch out on their own. It’s a risk – but this blossoming entrepreneurial spirit does bode well for a swifter recovery.
Concerns are rumbling in the background about the high level of indebtedness of the UK Government. The amount it’s forecast to borrow this year is certainly eye-watering - coming in at £392 billion. It’s the highest in real terms since World War II. But years of austerity meant that the public finances were not overstretched before the pandemic hit. So, although the UK has been loaned record amounts, borrowing should peak at 105% of GDP, compared to 250% during both world wars. It’s still a huge sum but ultra-low interest rates lighten the debt burden, and the Treasury’s interest payments to lenders via gilts and national savings are actually falling. The spectre of a possible spike in interest rates could expose the public finances further down the line, although gilt maturities have increased to an average of more than 18 years, pushing this thorny issue into the long grass.
Supercharged spending on capital infrastructure projects may seem extravagant when the debt burden is so high, but investment in green technology to power the future should help create jobs that are so desperately needed. A new infrastructure bank is also being set up help draw in new streams of funding, and although it may take time to generate interest, it should also help turn the tide.
There is also plenty of money washing around the economy right now, looking for a good place to land a decent return. The Bank of England has administered a large dose of medicine to the UK’s ailing economy by ramping up Bond buying with the aim of lowering borrowing costs. That has given a big boost to the money supply. Households have been putting away money at record amounts by paying down credit cards bills, placing deposits in banks, investing money into shares and National Savings. The Office for National Statistics says the savings ratio, which measures the surplus households have at the end of the month, has been rising at a record amount.
If the boom in UK assets is sustained, helped by a rebound in global growth, it could herald in a new Roaring 20s era, mirroring the decade long upswing following the economic pain of WWI.
Many companies have been able to shore up their balance sheets either by saving money themselves, by raising equity from investors or by borrowing cheaply from banks using schemes supported by the Treasury. Since the start of the year companies have raised £80 billion in net finance, that’s triple the usual amount raised, with three-quarters of that from government-backed loans. Much of that money is ready to be deployed once confidence returns, and optimism is seeping back into boardrooms following vaccine breakthroughs. Government support schemes have minimised insolvencies and although there is likely to be an uptick in failures once emergency help ends, the banking sector, as a result, is healthier than in previous recessions.
With a no-deal Brexit avoided, there has been a much smoother transition to new trading future than many had feared. Already fresh optimism has spread about the UK’s prospects with the FTSE 100 starting the new year on the rise. If questions surrounding the trade in services, not just goods, are resolved, that could spur on further recovery. Higher share prices should have a virtuous circle effect, enabling firms to ramp up investment further while also offering returns to shareholders. There will inevitably be a sector differential, with the prospects for oil and gas not simply guided by the oil price, but by the progress of their shift to renewable energy. There is a threat of regulation hanging over the tech sector, with moves being made in Europe and the US aimed at limiting the power of big tech. That would send ripples through the stock market but could also push investors into diversifying into smaller cap companies in neglected sectors instead.
If the boom in UK assets is sustained, helped by a rebound in global growth, it could herald in a new Roaring 20s era, mirroring the decade long upswing following the economic pain of WWI. Although the first half of 2020 is still likely to be a challenge given the fresh lockdowns, Capital Economics has forecast 7.5% growth next year and in 2022, which would be the fastest in living memory. The Office of Budget Responsibility’s forecast is soberer but still predicts a bounce back in growth of 5.5% in 2021 and 6.6% in 2022. But too rapid a recovery has equal risks. It may limit the need for tax rises but could spark a sharp rise in inflation. To avoid a crash further down the road, the pedal of government-powered investment will need to be eased on slowly, to ensure the economy revs up at just the right speed.
The UK economy grew by a record 15.5% from July to September, according to new figures released by the Office for National Statistics (ONS) on Thursday, ending a six-month recession induced by the first wave of the COVID-19 pandemic and subsequent lockdown measures.
The figures match the ONS’s initial estimate of GDP growth in Q3, though they fall short of economists’ predicted growth of 15.8%. Nevertheless, the July-September growth of 15.5% represents the largest quarterly jump in GDP the ONS has posted since records began in 1955.
UK GDP contracted by a fifth in Q2, the most extreme slump on record – and analysts have warned that the economy is likely to shrink again in the run-up to 2021 as renewed lockdown measures have been imposed across England, set to continue until 2 December.
In its release, the ONS noted that the Q3 recovery was driven in large party by household spending, while business investment remained “much weaker”. Though the recovery since July has been encouraging for investors, the UK economy as a whole remains 10% below 2019 levels.
September-specific data from the ONS revealed that the economy grew by 1.1% during the month, indicating that the pace of the UK’s economic recovery has slowed significantly.
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“Today’s figures show that our economy was recovering over the Summer, but started to slow going into Autumn,” said Chancellor Rishi Sunak in a statement. “The steps we’ve had to take since to halt the spread of the virus mean growth has likely slowed further since then.”
Samuel Tombs, Pantheon Macroeconomics’ chief UK economist, predicted that GDP would shrink by around 0.5% during Q4, with little chance of recovering to September levels until spring of 2021.
The worst of the COVID impact on the major economies does seem to be over. Many of the economic activity indicators point to a V-shaped recovery from the slump in output and consumer spending back in March and April. Indeed, equity markets responded to the swift and unprecedented global and monetary stimulus at the time by quickly moving out of bear market territory with US equity markets going on to make new highs in early September before making a sudden 10-12% correction. US tech stocks are very over-valued and a ‘dot-com2’ cannot be ruled out. A stock market crash and bursting of the ‘Everything Bubble’ would come at a very unfortunate time. Otherwise, you will recall that early on in the pandemic, economists went through letters of the alphabet in trying to determine the shape of the prospective economic recovery. Optimists went for V; two-handed economists went for W and pessimists went for an L. The optimists have been right so far.
However, in these uncertain times, it is not difficult to come up with a long list of reasons to join the pessimists. These include the threat of fresh lockdowns in response to rising COVID infections through a more muted increase in the fatality rate. The advice to governments must be to avoid widespread lockdowns and to make sure that we do not end up in a disastrous economic slump. Unemployment still remains high and there may well be further job losses post-COVID as employers cut headcounts and understand that during the lockdown, they could operate their businesses in most part with a more productive workforce. Unfortunately, it is those people that don’t work in an office and can’t work from home that have been the most affected by the COVID-recession. The pandemic has also worked as an accelerator of ‘disruptive’ technologies as well as potential changes in working practices, though it will be interesting to see whether there is push-back from ‘working at home’.
Other uncertainties include the outcome of the 3rd November US Presidential Election. The opinion polls and betting odds (see electionbettingodds.com) point to Joe Biden winning the White House with a relatively high probability of the Democrats winning a ‘clean sweep’ of the House and the Senate. A key feature of Democrat economic policy is to overturn the President’s tax policies, in particular, an increase in the US corporate tax rate to 28% and the imposition of a wealth tax. More likely is a badly needed infrastructure program that can support growth and jobs.
Central banks won’t admit it, but their actions are what used to be called debt monetisation. Welcome to the world of MMT (Modern Monetary Theory or the Magic Money Tree, take your pick).
However, in the current economic environment, tax increases may end up being deferred. The US economy needs to secure a sustainable recovery and policymakers should not make the mistake of implementing a fiscal squeeze even though US fiscal settings are regarded by the independent Congressional Budget Office (CBO) as being ‘unsustainable’. The same advice applies to other governments. Fiscal ‘austerity’ is exactly that and delivers economic ‘austerity’. The Eurozone is a classic case of wrong economic policies where the recovery is already faltering and where the Eurozone is experiencing mild deflation despite ‘excess liquidity’ from the European Central Bank (ECB) amounting to €3 trillion, a doubling in a period of only 6 months, and an ECB balance sheet that has exploded to above 50% of GDP (compared to nearly 35% for America’s Federal Reserve). Much fanfare greeted the EU’s Recovery Fund back in July but most of the measures do not come into effect until next year thus mitigating any direct fiscal impact on growth. The Eurozone is turning ‘Japanese’ and looks as though it is stuck in a liquidity and debt trap. No wonder that the Stoxx600 Bank share index just recently made a record low. That is mostly thanks to the effect of negative interest rates which are deadly for bank profitability as well as denting savings which are an important fuel for providing investment. Which brings us to Brexit and the ‘deal’ or ‘no deal’. Unless you are a remainer and a firm believer in the worst prognostications of ‘Project Fear 2’, you could not be blamed for thinking that it is the Eurozone that is the loser from Brexit and a ‘no-deal’ scenario. A ‘deal’ only works, as in life, if the deal is mutually beneficial and not coercive. At the time of writing, the odds of a deal characterised by zero tariffs and zero quotas is about 50-50. For what it is worth, I favour Brexit both from a political and economic perspective and see the prospect of favourable opportunities globally going forward.
Back to the US. The cost of the recession and the various fiscal programs enacted so far are likely to show up in a US budget deficit in this fiscal year that amounts to 16% of GDP with US federal deficit hitting 100% of GDP. The CBO warn that on existing policy trend that the federal debt could end up being nearly 200% of GDP by 2050. Of course, if this is not sustainable, it won’t be. The history of US fiscal policy shows that actually it is Democrat Administrations that end up reversing Republican fiscal profligacy.
More interesting is what the Fed does. Monetary policy entered the so-called ‘uncharted territory’ some time ago. Zero-interest rates, negative rates, QE are now all a matter of course. Central bank independence has become an illusion and central banks have become funders of Treasury debt issuance. Central banks won’t admit it, but their actions are what used to be called debt monetisation. Welcome to the world of MMT (Modern Monetary Theory or the Magic Money Tree, take your pick). With global debt-GDP at a record high, the risk is that policymakers covertly rely on an increase in inflation to reduce the real value of debt. At the moment, the major government bond markets think that there will be no inflation. The increase in the gold price suggests that some investors think otherwise. Bond yields are still near historic lows and market-based measures of longer-term inflation expectations remain subdued. The US dollar has not collapsed though the emergence of the ‘twin deficits’ is a currency-negative for the longer term.
In the meantime, it is back to China. So far so good. The economy is recovering, admittedly propelled by significant credit expansion and some measures to promote infrastructure spending. Exports are starting to recover which is good for the Asian region, and the Chinese currency has appreciated thus helping the export competitiveness of its Asian trading partners. There are risks with Chinese corporate debt especially in the real estate sector, but the central bank has big pockets. Relations with the US still remain tense and President Trump’s trade dispute with China has not been to America’s trade disadvantage as the trade gap with China has not improved. A win for President Trump in the election cannot be ruled out given previous unreliability of the opinion polls, and fresh tensions with China could easily emerge. Some geopolitical experts warn that there are other risks related to the relationship between China and Taiwan for example. The shape of the global economy and shape of the international financial system has changed and will continue to change, but it is the US and China that will determine the pace of such changes.
The UK economy grew by 2.1% in August, marking the fourth consecutive month of economic expansion following its record slump of 20.4% in April.
However, this growth was slower than the expansion of 8.7% seen in June and 6.6% in July, according to new figures released on Friday by the Office for National Statistics (ONS). Economists had forecasted a monthly growth of 4.6%.
The slowdown comes in spite of a boost for the hospitality sector through the government’s Eat Out to Help Out scheme, which helped to lift output in the food and accommodation industry by a staggering 71.4% in August. Discounts for over 100 million meals were claimed through the scheme.
“The combined impact of easing lockdown restrictions, Eat Out to Help Out Scheme and “stay-cations” boosted consumer demand,” the ONS noted.
More than half of the UK’s economic growth during August stemmed from the food and accommodation industry. Meanwhile, the manufacturing sector grew by 0.7% and the construction sector grew by 3%, respectively 8.5% and 10.8% lower than February figures.
The economy as a whole remains 9.2% smaller than pre-pandemic levels. The latest release from ONS is likely to put an end to hopes of a V-shaped recovery for the UK’s economic output.
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Analysts have warned that the UK’s economic recovery is likely to peter out further as new COVID-19 restrictions come into place, the furlough scheme ends by November, and concerns of a no-deal Brexit grow more pressing.
“Although the UK remains on course to exit recession in the third quarter, the looming triple threat of surging unemployment, further restrictions Wand a disorderly end to the transition period means the recent rally in economic output is likely to be short-lived,” said Suren Thiru, head of economics at the British Chamber of Commerce. “The government must stand ready to help firms navigate a difficult winter, beyond the Chancellor’s recent interventions.”
Figures posted by the Office for National Statistics (ONS) on Friday showed UK GDP grew by 6.6% in July, the most recent month where data is available. This marks the third month of economic expansion in the country.
However, the growth observed during July was slower than the 8.7% GDP rise in June and remains 11.6% down from February levels. It also did not quite reach analysts’ projections of 6.7% growth.
The ONS noted that, while it is on the path to recovery from the initial shock of the COVID-19 pandemic, the UK "has still only recovered just over half of the lost output caused by the coronavirus”.
UK GDP fell by over 20% between April and June, precipitating the country’s worst recession on record. The outbreak of the COVID-19 pandemic and resulting lockdown measures dealt severe damage to the country’s tourism, retail and hospitality sectors.
The growth seen in July was due in large part to the reopening of pubs, restaurants and hairdressers during that month, boosted by the government’s Eat Out to Help Out scheme. The construction industry saw the best performance out of all sectors during July, though its output remains 11.6% below pre-COVID levels. Manufacturing also remains 8.7% down.
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Also on Friday, the Treasury Select Committee suggested a targeted extension of its furlough scheme, warning of mass long-term unemployment and the potential for viable firms to fail due to a lack of government support. The furlough scheme is set to end in October.
The Treasury added that it would "continue to innovate in supporting incomes and employment."
It seems an absolute denial of common sense – how can markets thrive in a time of economic mayhem? Conventional wisdom – as I recently read in a US Investment Bank’s equity strategy note - tries to explain the gains in terms of: “Markets anticipate better days ahead. Although the timing is uncertain, the stock market is expressing confidence the pandemic will end with a vaccine and better treatments in the interim.”
Really? Markets are supposed to be rational. A vaccine tomorrow will not undo the damage already done and at best could only accelerate a recovery back to where we were. Corporate earnings may take years to recover. Betting big on the hope of a vaccine sounds like an irrational toss of the dice. And…hope is never a good investment strategy.
To understand why markets are so strong you need to follow the implications and consequences of government, and particularly, Central Bank action. Markets follow the money – and that requires you forget everything you thought you knew about stocks, bonds, prices and future valuations. Concepts such as the ability of a firm to generate future growth, or earnings before tax and interest, or even its likely ability to repay its borrowings, are no longer relevant in today’s markets. Put away that copy of Benjamin Graham’s ‘The Intelligent Investor’, it will not be needed these next 30 years, and dispense with notions like fundamentals or value.
Today there are new themes to consider.
Markets are no longer setting prices. The “invisible hand” of markets efficiently allocates capital based on demand and supply representing the summation of what every market participant believes. It ensured companies were disciplined to perform strongly. Failing companies were punished by stock price falls and wider bond spreads.
But that price-setting function has been replaced by an implicit understanding that Central Banks will do “whatever it takes” to avoid a market meltdown. It no longer matters what investors really think about the economy – if they are certain Central Banks will bail them out, then that dictates their investment behaviour.
What matters most in today’s hyperbolic market are the consequences of Zero Interest Rate Policy (“ZIRP”) and QE Infinity. ZIRP absolutely distorts the assessment of risks vs returns. QE is the process by which Central banks have flooded markets with liquidity since the Pandemic erupted to stave off an immediate recession, corporate insolvencies, and a catastrophic market crash. They have succeeded but at an enormous cost.
It’s been the limitless Central Bank liquidity and the promise they will do, even more, that has caused Financial Assets (Bonds and Equity) to soar. The investors who understand the process are simply following the money – arbitraging the implied Central Bank “put”. They know the economic damage that’s been done, how corporates are closer to bankruptcy than ever, and that global demand and supply remains absolutely stressed. They aren’t investing on the basis of recovery – they are simply investing on the basis that Central Banks have no option but to continue bailing them out.
Markets follow the money – and that requires you forget everything you thought you knew about stocks, bonds, prices and future valuations.
It’s been a wild and improbable ride. At times it felt like markets were out of control. Although there are stories like a hybrid truck-maker being worth more than Ford despite not having delivered a single vehicle, this rally started with less of the “Irrational Exuberance” that has characterised other historical stock market price bubbles. What we have this time is a bubble and price distortion deliberately created by Central Banks.
The smart money knows the Central Bankers have little choice but to sustain it. Not everyone is smart money. Most investors are followers and are all too easily persuaded of the merits of a snake oil that promises enormous returns. Who wants to listen to sage market professionals warning of the dangers of Central Bankers setting market prices when stocks are going ever higher?
Most investors aren’t particularly aware of the Central Banking shenanigans going on under the surface – what they see is a market going up and up. FOMO (the fear of missing out) is one of the most powerful forces in finance. That’s particularly relevant in terms of the funds management industry – where complacent investment managers are far more concerned about career-risk rather than market-risk. Missing a rally like the one we’ve seen since March would be a career-limiting mistake. Career risk explains why most investment managers do a little more than benchmark themselves to indices.
The rally has developed a momentum all of its own - sucking in buyers who fail to see the dangers implicit in herd mentality and the triumph (in many cases) of hope over common sense. The rise of “Robin Hood” retail day-traders unburdened by conventional market wisdom says it all – they genuinely believe the most dangerous four words in the market lexicon: “this time it’s different”.
The rally has developed a momentum all of its own - sucking in buyers who fail to see the dangers implicit in herd mentality and the triumph (in many cases) of hope over common sense.
Long-term… It’s never different.
In the short-term, QE Infinity is working. Cash-strapped corporates have been able to borrow the money they need to see them through lockdown at ultralow interest rates. Widespread insolvency and default has been avoided. Investment banks are all advising their clients to buy corporate debt and finding reasons to promote stocks. That’s their business model - to sell financial assets.
But there will be consequences.
As prices head stratospheric, it’s caused returns to plummet. The result is Financial Asset Stagnation – bonds and stocks cost more but are worth less. That’s triggered a desperate search for meaningful returns in an increasingly repressed market where yields are trending towards zero. Pension funds are dipping into their capital to meet their liabilities. The only way to improve returns is to take more risk – hence normally staid bond investors find themselves sucked into equity markets as “yield tourists” in order to squeeze some returns from their portfolios.
This is going to prove a massive long-term problem. Ultra-low interest rates and unlimited liquidity are boosting markets but make long-term investment planning impossible. The value of a typical pension fund has increased, but the size of pension it can fund has dramatically lessened.
It’s hard to see how Central Banks can now exit their role of handing out free cash to markets. More and more companies are now dependent on cheap debt. Sovereign nations are running up borrowing to pay for it all. At some point, can the money that’s bailing out markets run out? Not necessarily – interest rates are effectively zero, and the money creation by Central Banks costs nothing. (Unless it causes a crisis of confidence in the underlying currency, which cause devaluation and inflation - but if every country is doing the same thing… why would that matter.)
The devil is in the detail. The market is no longer disciplining bad companies or forcing them to invest, plan and develop sensibly. Terminally stupid and financial challenged companies, like Boeing, have been able to borrow billions at record low-interest rates despite manifest corporate failings. If the market doesn’t discipline companies – who does? Hence the rise of the dangerous ESG (Environment, Social and Governance) approach to investment – only buy companies that pass unquantified tests on what is good and bad. It’s a form of financial woke – and makes even less sense. A company that is well managed and led (Governance) will always do better.
And what do companies do with all that money they’ve borrowed? Up until the coronavirus, a significant amount of debt was raised to finance stock buybacks – doing nothing in terms of financing value-added productive assets, but simply pushing up the firm’s stock price and inflating executive bonuses! The first half of 2020 has seen record volumes of new corporate debt issued on the markets, mainly to finance the costs of the virus shutdown. None of the debt is creating new jobs or new factories – it’s increased leverage simply to stay still.
There is no doubt Central Bank action has created an enormous financial asset price bubble. The question is – will it pop? Can Central Banks risk it? It is probably worth reminding readers of my number one market mantra: “The market has but one objective: to inflict the maximum amount of pain on the maximum number of participants”.
New data from the Office for National Statistics (ONS) has revealed that UK government debt passed £2 trillion for the first time, reaching £2.004 trillion in July -- £227.6 billion more than last year’s figure.
The unprecedented rise in government borrowing in 2020, with the months of April to July each posting the highest levels of borrowing since records began in 1993, can be credited to spending on anti-COVID-19 measures like the Coronavirus Job Retention Scheme. ONS remarked that this is the first time that government debt has risen above 100% of GDP since the 1960-61.
Ruth Gregory, senior UK economist at Capital Economics, noted that July’s borrowing figure of £150.5 billion “is close to the deficit for the whole of 2009-10 of £158.3bn, which was previously the largest cash deficit in history, reflecting the extraordinary fiscal support the government has put in place to see the economy through the crisis."
Coinciding with the new release on government debt, further data showed that activity in the UK’s private sector grew at its sharpest rate since 2013 during August. The Composite Purchasing Managers’ Index (PMI) read at 60.3 on Friday, beating analysts’ expectations and easily surpassing July’s figure of 57, indicating accelerated growth across the sector.
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“The combined expansion of UK private sector output was the fastest for almost seven years, following sharp improvements in business and consumer spending from the lows seen in April,” commented Tim Moore, economics director at HIS Markit.
Meanwhile, separate figures from the ONS also revealed that the UK retail sector rebounded faster than expected between June and July, with a 2% increase in sales volume where analysts had predicted only 0.2%.
The quantity and value of total reported also saw an increase of 4.4% from February, beating pre-lockdown figures.
Figures released by the Cabinet Office on Monday revealed that the Japanese economy shrank at its fastest rate in history between April and June, owing to the impact of the COVID-19 pandemic.
Japan’s GDP fell by 7.8%, or 27.8% on an annualised basis. This marks Japan’s third successive quarter of economic contraction – its worst performance since 1955 – having slipped into recession earlier this year. The fall also wiped out the gains brought by Prime Minister Shinzo Abe’s “Abenomics” stimulus policies, which were rolled out in 2012.
The previous worst contraction in Japanese history was an annualised 17.8% drop in the first quarter of 2009 as the global financial crisis took hold.
Takeshi Minami, chief economist at Norinchukin Research Institute, noted the COVID-19 pandemic and resultant lockdown measures’ impact on sales as the prime cause for the contraction. “The big decline can be explained by the decrease in consumption and exports,” he said.
“I expect growth to turn positive in the July-September quarter. But globally, the rebound is sluggish everywhere except for China,” he added.
The struggle to weather the impact of COVID-19 has compounded Japan’s economic worries, with 2019 seeing sales tax rise to 10% as well as widespread damage caused by Typhoon Hagibis in October.
Japan’s severe economic downturn mirrors that of other nations. US GDP declined at a rate of 32.1% in the last quarter, while the UK fell by 20.1%.
The UK is on course for a V-shaped recovery from the damage wrought by the COVID-19 pandemic, according to the chief economist of the Bank of England (BoE), Andy Haldane, has estimated.
In an online speech on Tuesday, Haldane acknowledged the continued risk of high and persistent unemployment across the country, but “[his] reading of the evidence is so far, so V.”
Haldane, who was the only member of the BoE’s Monetary Policy Committee to vote against the expansion of its government bond-buying programme earlier this month, said that business surveys have indicated an economic recovery that will come “sooner and faster than any other mainstream macroeconomic forecaster” has thus far predicted.
Regarding his reluctance to see the bank inject another £100 billion into the UK economy, he noted a risk of creating a “dependency culture” where the country’s financial markets would become accustomed to the bank addressing all economic problems with cash solutions.
Despite his vote against expanding the bank’s asset purchase programme, Haldane voted along with the other eight members of the Monetary Policy Committee to keep interest rates at a record low of 0.1%. In his Tuesday webinar, he declined to comment on whether or not a negative interest rate was being considered.
A review on the subject would not be complete until “well into the second half of the year”, he said.
