Now that the lockdowns are being relaxed in most advanced countries it is time to take stock of how much damage has been done by placing much of humanity under house arrest for three months. The markets take one view; Victor Hill takes another.
Times of trial
I cannot think of a time in modern world history when a health crisis converged with an extreme economic downturn and a social fissure tore open like a sinkhole all at the same time.
The Covid-19 pandemic is, thankfully, well past its peak in most of the developed world – though the numbers coming out of Brazil are worrying; and indeed the epicentre of the pandemic, according to the WHO, is now South America where there are likely to be many more deaths. Lockdowns are being relaxed everywhere yet the virus will continue to linger for some time to come such that sensible measures like social distancing and meticulous hygiene will persist for the foreseeable future. But it will most likely take years to recover from the economic consequences of the lockdowns, particularly in so far as government finances are concerned.
And then there is the matter of a substantial section of the population in the USA, Britain and elsewhere effectively in open revolt. Of course, the proximate cause of the explosion of demonstrations across America, many of which have spun out of control with looting and rioting, was the killing of an African American, George Floyd, 46, by a white police officer in Minneapolis on 25 May. That unleashed a tsunami of anger around social justice issues – and it’s not my task here to opine on whether that anger is justified or not. What I note as an analyst is that the killing came at a time when America was experiencing unprecedented levels of unemployment as a consequence of the lockdowns, with a disproportionate number of African Americans having been laid off. And African Americans – like their black British counterparts – have experienced a disproportionate level of mortality from the pandemic itself: partly for reasons that we well understand and partly for reasons we don’t. A spark requires combustible matter in order to kindle a flame.
The social fissure which has opened up (though it is not new) has the potential to destabilise social relations and thus economic prosperity for years to come. In Britain and America it’s not just a matter of which statues and monuments should be torn down, but rather whether social cohesion can be maintained at all.
For all this, the markets have been buoyant – until yesterday when all three Wall Street indices were down by around 7 percent. The NASDAQ has been trading at record highs, propelled by the big tech stocks which have all been major beneficiaries of the pandemic. The ponderous FTSE-100 has been slowly recovering – up around 20 percent from its 23 March low point even after yesterday’s losses – though it is still well below where it started the year (7604). Even the European bourses have been heady. Global stock markets seem to be looking through the concatenation of crises to a more settled end point.
The question is: is this confidence justified? Even mature cash generative companies are cancelling dividends hand over fist and analysts expect an avalanche of dire earnings numbers. (Shell (LON:RDSA) has cut its dividend for the first time since WWII). Or have the markets been usurped (again) by the hocus pocus of monetary policy conjured by central bankers? And even if it is the role of central banks to sustain the markets, what is the risk that inflation could ensue?
The viral paradox
The conventional wisdom was that diseases that get out of control are much crueller to poor countries which have subsistence-level healthcare systems than to rich countries such as the United States which spends nearly 17 percent of its massive GDP on healthcare. And, indeed, the UK, as I have discussed in these pages previously, has sustained comparatively awful mortality statistics despite (or perhaps because of) its colossal and quasi-sacred National Health Service.
But that’s not how the Covid-19 pandemic of 2020 played out. It was the rich countries – with the exception of the East Asian Tiger economies – that were most seriously affected, while developing countries in Africa and elsewhere shrugged through it with minimal fatalities. Kenya has a basic healthcare system but, so far, has suffered only 3,215 cases and just 92 fatalities[i]. That compares with the UK which has recorded 291,409 cases and 41,279 fatalities according to the official figures (which are almost certainly an underestimate).
The fact that the richest countries have been most adversely affected by this pandemic mean that global GDP is likely to record an unprecedented decline this year – 6 percent according to an OECD report released on Wednesday (10 June) with Britain’s economy shrinking by a catastrophic 11.5 percent. Figures released this morning by the ONS show that in April the UK economy contracted by 20.4 percent on a year-on-year basis.
The economic damage is two-fold. First, there is the loss of consumer spending – meals not eaten in restaurants, holidays not taken and so forth. And second, there is the impact on overall employment as a swathe of businesses become unviable and the consequent loss of economic capacity. In the UK alone, McKinsey and Company thinks that nearly a quarter of the workforce or eight million people are vulnerable to either reduced income or losing their jobs altogether. 80 percent of workers in the hospitality sector were furloughed in April together with 40 of construction workers. Many of these will not get their jobs back when the furlough scheme is discontinued in August/September (even though there is likely to be a holiday for employers’ national insurance contributions).
And it seems that the most vulnerable workers are the most at risk. Certainly, young people have been badly affected by the interruption to their education and the effective cessation of hiring. People on low incomes, part-time workers and those without higher education have also been disproportionately affected. The outcome could be an increase in income inequality once the economy fully re-opens – something that was not pre-figured by the Johnson government’s levelling-up agenda. The food banks, I’m told, are doing record business.
According to StepChange, a charity concerned with issues around household debt, the poorest households in the UK have racked up an additional £6 billion of debt, with many lower-income families having fallen behind on payments forced to borrow to make up the shortfall.
Lucky for some
That is not the whole story. According to a report out this week from the left-of-centre Resolution Foundation, nearly two million households will emerge from lockdown better off. About 40 percent of high-income working-age families have strengthened their household budgets since the pandemic began. This is because, based on a survey of 6,000 people, the inability to spend money on meals out, holidays and entertainments has resulted in additional enforced saving without any concomitant fall in income. Credit card spending, significantly, has collapsed – bad news for VISA (NYSE:V), MasterCard (NYSE:MA) and others; but contactless payments on debit cards (now with a maximum of £45 in the UK) have soared.
This suggests that once the hospitality sector re-opens in the UK there will be a surge of pent-up demand, especially at the higher end. And that is exactly what we will need to keep thousands of small hospitality businesses alive. They may also benefit if better off families decide that a foreign holiday involving flights is not worth the hassle this year and opt instead to remain in the UK.
Logistics companies are also set to prosper also after the lockdown is relaxed. The Franklin Mid Cap fund is allocating to LondonMetric Property (LON:LMP). The fund also sees potential in consumer stocks, food retailers, travel and leisure, though it does not expect a full recovery for 2-3 years. It has made huge gains on Avon Rubber (LON:AVON)which makes personal protective equipment such as respiratory masks.
In an extraordinary and little reported move in late March the UK government effectively implemented one plank of Mr Corbyn’s manifesto last December: they surreptitiously nationalised the railways. Up until then most train operators collected the fares and paid the UK Treasury a fixed fee. But that month Grant Shapps, Secretary of State for Transport, turned rail finances head over heels. For the next six months train operators will receive a fixed fee from the Treasury while the government will collect the fares. The UK government already ran the East Coast main line and Northern franchises directly. Most of the private train operators like Trenitalia (state-owned), which operates C2C running from London to Essex, are losing money. Those losses are likely to get worse as more people opt to work from home.
And it would not be surprising if the government ends up with an equity stake in one or more of the airlines which make Heathrow such an important hub. State intervention, fiscal activism and aggressive monetary policy will be the hallmarks of what Fidelity International is already calling the New Economic Order.
One of the seminal outcomes of the pandemic will be the recalibration of the West’s relationship with China. I note that $6 billion of US federal retirement funds (CalPERS et al) will no longer be invested in the Chinese stock market. If the Chinese, for their part, stop buying US T-bills in a tit-for-tat that could be interesting.
Meanwhile, China has used the fog of the health emergency to assert sway over Hong Kong – a former British colony that became a Chinese colonial possession in 1997. China’s proposed violation of the Sino-British agreement of 1984 (which guaranteed two countries, two systems for 50 years) has sent the Hang Seng reeling.
The UK Treasury borrowed £62.1 billion in April – the largest monthly figure in history and roughly what the government borrowed in the entire fiscal year 2019-20. In May and June it is likely to borrow a further £180 billion. The UK economy is likely to have fallen by 20 percent by the end of Q2 2020 year-on-year. Retail and fuel sales will have plunged by even more than that. The cost of the furlough scheme amounts to £21 billion for March and April alone. The cost of the additional nearly two million people claiming Universal Credit in the UK is as yet unquantified.
On the revenue side of the national finances the picture is even more depressing. In April 2019 the government raised £13 billion in VAT. In April this year it paid out a net £900 million in VAT refunds as rebates to companies exceeded VAT collected. Across the board the tax-take has crashed. The national debt has jumped by over 17 percent in barely two months to £1.9 trillion or about 97 percent of GDP.
On the other hand, for the first time ever in late May, the UK government issued a bond with a negative interest rate. Inflation is subdued at barely 0.8 percent. A five-year gilt issue recently carried a yield of 0.04 percent. Why would investors go for that? Basically, gilts are still a safe haven in a choppy sea. Moreover, the Bank of England bought £200 billion of government bonds last month with invented money. And the share of government revenues spent on servicing its debt is still low at around just 4 percent. It was over 15 percent in 1947 just after WWII.
But over the medium-term tax rises are inevitable – even if they will be politically unacceptable in the forthcoming July emergency budget. I suspect that Mr Osborne’s pension triple lock (the guarantee that state retirement pensions will rise by the highest of wage growth, inflation or 2.5 percent) will be jettisoned soon. That could save the government £20 billion over five years according to the Social Market Foundation – but will go down badly with pensioners.
The tracking and tracing revolution, about which I wrote in the June edition of the MI magazine, seems to have stalled. (Not just in Britain but in America too). Without that in place – and ultimately a vaccine – there will be no return to “normality” even if the lockdown is substantially relaxed. Britain has suffered a monumental economic shock – even though most people haven’t felt it yet in their lockdown bubbles where they have been enjoying the sunshine.
In recent years major stock markets have become detached from the underlying economies in which they operate and have little predictive value in so far as future economic activity is concerned. That is partly due to de-equitisation (the number of listed entities has been falling drastically) and because numerous markets, most obviously the NASDAQ, are driven by a few very large companies with enormous market capitalisations. Shares in companies with abundant cash, low leverage and low debt service costs will always be more resilient in an economic downturn. According to McKinsey 10 percent of all public companies generate 80 percent of total global profits.
But the real pain – of reduced incomes, mass unemployment, crippled government finances, inevitable tax hikes, reduced pension income, mounting inflationary pressures, increased regulation and more social strife – is yet to come. And that’s even if there isn’t a second wave.
The reason why there was an elegant statue of Edward Colston in central Bristol (erected in 1895) was because he was a philanthropist who endowed schools, alms-houses, hospitals and churches in Bristol, London and elsewhere. He probably derived some of his fortune from his investments in the Royal African Company – but it is a bit of a stretch to call him a slave trader.
Similarly, the reason that there is a statue of Cecil Rhodes in Oriel College, Oxford is because he left much of his fortune – made largely from South African diamond mines – to endow the college where he was an undergraduate. Thousands of students from around the world – including many from Africa – have benefited from Rhodes Scholarships to Oxford University over a century or more. The BBC refers to the imperialist Cecil Rhodes. That is peculiar: virtually all politicians of the last quarter of the 19th century and the first quarter of the 20th were imperialistsin the sense that they thought that the British Empire was a force for good. Rhodes was a prime minster of Cape Colony – so he is as much a part of South Africa’s history as ours. In fact, a statue of him still stands in Company’s Garden, Cape Town.
I’m not saying let their statues stand for evermore. It is healthy for a nation to re-evaluate its history periodically, though not to denigrate it. But that should be done after enlightened and inclusive deliberation – not by a rabid mob hell-bent on an unsought cultural revolution.