We share one other common outcome of conflict.
- Monday, May 11, 2020
The 75th Anniversary of when WW2 ended in Europe gives us all an opportunity to reflect upon the past and to look forward as they did in 1945, to better days ahead. Just like then, we are facing an uncertain future, but through our collective resolve and social discipline it now looks as if we have turned a corner in our battle against Coronavirus.
As we celebrated the brave endeavours of the heroes of 1945 and heroes of 2020, we also share one other common outcome of conflict. UK national borrowings rose to 259% of GDP at its war time high, today it stands a £1.8tn or 79.1% of GDP. The government is now borrowing £60bn per month and the Office of Budget Responsibility (OBR) predicted the cost of Covid-19 measures to be £104bn. The UK deficit in 2019/20 was £48.7bn and it is feared that the Coronavirus crisis could push the deficit to £260bn.
The Bank of England warned last week that UK GDP will fall 25% in Q2, but will then recover in Q3 and Q4 but not reach pre virus levels until 2022.The BoE made no changes to either the UK interest rate or to the scale of the quantitative easing (QE) programme. Whilst there was no change to the overall level of asset purchases the Monetary Policy Committee did note “that the stock of asset purchases will reach £645bn by the beginning of July, at the current pace of purchases.” Given the economy and financial markets will likely still need liquidity assistance at this point, the BoE will need to reassess the current amount of committed capital. Sterling was broadly unchanged as markets expect this further accommodation in the months ahead, especially given the Bank has reaffirmed that it “stands ready to take further action as necessary to support the economy.”
With £180bn of gilt issuance in Q2 to pay for Covid-19 measures the QE bond buying programme will continue. There is some suspicion that the BoE QE programme will be purchasing the governments gilt issuance and therefore directly funding the deficit. Even though the BoE does not purchase gilts in the primary (direct) market and only in the secondary market, the link in size and timing is a remarkable coincidence.
There is a fine balance to be made between health and wealth as the country moves out of lockdown. There is also a balance between the government paying or subsidising the wages of 6.3 million PAYE workers and 5 million self-employed workers and how long can this go on for. The important furloughing scheme currently costs £8bn per month and could yet rise to 7 million recipients. The ongoing sustainability will depend upon the rate of return to work over the next few months. It is not surprising that Chancellor Rishi Sunak is considering both extending the scheme and reducing benefit levels.
The IMF is forecasting that the deficits in advanced economies will average 11% of GDP and that average national debt to GDP will hit 122%. Due to the 2008 financial crisis there was a urgent need to rebuild balance sheets, this has resulted in a global economy not ready for another deep recession. The Institute of International Finance (IIF) has recently published data that indicates that global debt is over US$255tn. This figure includes all government, corporate or personal debt and equates to 322% of world GDP. This debt level is 40% higher than prior to the 2008 financial crisis.
It is not just government debt that has grown, companies now have higher borrowing as a result of cheap money. US corporate debt is currently the equivalent of 70% US GDP. With the recession looming, Finch, the ratings agency, is predicting a doubling of corporate credit defaults to 5%-6%.
The growth in global borrowing is being financed through the massive QE bond purchasing programmes first started in November 2008 by the Federal Reserve and are still active today. The fiscal support to the global economy has given stability and liquidity to markets and as a result, boosted the balance sheet of the major central banks.
The debt pile is manageable while interest rates are at near zero and the outlook for inflation is weak due to low demand, the oil glut and high unemployment, but by the time we get to 2022, the inflation outlook may be different.
The ability of the world to work its way out of the debt depression is to reduce the debt’s relative value through inflation, but at the same time keeping interest rates and repayment costs low. This exit strategy will be just as challenging as the progressive relaxation of lockdown.
The Prime Ministers address to the nation last evening, gave us a route map for the easing of lockdown. He was cautions that we do not undo the great work achieved already and risk a second wave. We are told that 700 building sites re-opened last week and car movement is now about half that of normal road traffic usage. Garden Centres can open this week and he encouraged some sectors including offices and factories to return to work so long as social distancing measures and hygiene guidelines can be respected. Primary schools could re-open from 1st June for some school years in England but no such announcement has been made in Cardiff. In Wales, the stay at home message remains while for England it is replaced by a stay alert message that focuses on an awareness of social distancing.
These collective measures suggest that the economy can progressively increase its rate of recovery. This will be vital in easing the costs to families, businesses and the tax payer. Stock markets have responded to the global easing of lockdowns with a general upward momentum in stock values. Economic surveys that track expectations for the economy for the next 12 months have also started to improve.
In March, China’s exports fell by 6.6% and US retail sales were down 8.7%. Given the global lockdown one might have expected these figures to be worse. April’s figures when released will confirm far greater falls but it is possible that May’s figures could show an uplift. One of the factors that has eased the economic decline is the ability of more people to work from home and the growth of on-line shopping. These factors are the achievements of advancing technology.
All the prevailing economic news is of a deep and hard recession and one that will take time to recover from. The IMF is expecting the world economy to contract by 3% this year and that corporate earnings will fall significantly. The S&P 500 earnings forecast is down 16% year on year, but still markets have looked past these dire statistics and have recovered significantly from their end of March values. The S&P 500 is up 30.9% and FTSE 100 up 18.8% since the floor of 23rd March. This suggests that the worst of this pandemic is over.
It looks like stock markets have already decided on the long-term winners of the coronavirus crisis. It only takes a glance at the way prices have moved over the past month to identify which companies, sectors and countries are doing better and those that are not. The tech giants like Google, Amazon, Microsoft, Facebook and Netflix have all done well. The US stock market has significantly out-performed the UK, Europe and Japanese markets due to its global tech brands.
The VE Day 75th Anniversary gave us an opportunity to reflect upon the past and to look forward to better days ahead. Just like then, we are facing an uncertain future, but through our continued collective resolve and social discipline we can win this battle against Coronavirus.
Chris DaviesChartered Financial Adviser
Chris is a Chartered Independent Financial Adviser and leads the investment team.