In the November issue of Investment Outlook, we discuss: how the global economy shows resilience to COVID-19 headwinds.
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Notwithstanding recent market volatility from rising new COVID-19 cases in parts of Europe, global equities have recovered their losses from the pandemic sell-off in March and including dividends reinvested are broadly flat year-to-date1. Stock prices have undoubtedly been helped by unprecedented fiscal and monetary stimulus to boost market liquidity and stimulate the global economy. Along with the lifting of lockdowns, this has led to a rebound in private consumption globally.
In the USA, September underlying retail sales rose 9.1% from a year ago, the fastest growth rate on record from data that starts in 19932. Elsewhere, UK retail sales were 7% higher than they were in February3.
One area where policy has particularly boosted growth is in the residential sector. US existing home sales are running at their highest rate since the boom of the mid- 2000s and in the UK, lower stamp duty has triggered a rush of housing activity, with mortgage approvals (a lead indicator of sales) running at their fastest pace since 20074.
There are some areas, however, such as hospitality and travel, where expenditure has been slow to recover. The International Air Transport Association does not expect global air passenger traffic to return to pre-COVID-19 levels until 20245. Nevertheless, equities appear to be ignoring the growth impact on the economy from the recent spike in new COVID-19 cases and are looking through to 2021 in a more positive frame of mind.
Consumers save the day for equity markets
Back in our July Investment Outlook we argued that this business cycle could be extended beyond an initial rebound as the economy reopened. Our optimism was partially driven by consumers having the financial wherewithal to sustain spending. A way to measure this consumer spending power is to look at the drivers of the household savings rate (a measure of unspent monthly income as a share of take-home pay). In the UK, the household savings rate rose to a record 28% in the second quarter, against a 60-year average of 9%, helped by government fiscal handouts .
While it could be argued that the worry caused by the pandemic lifted voluntary precautionary savings, it can also be argued that in fact much of the rise in savings was involuntary. In other words, consumers may have been unable to spend; for example, when non-essential stores were shut and holiday makers were unable to travel (or deterred due to quarantine rules). Looking forward, we believe there is room for these savings to now be used to sustain consumption after the lockdown has been lifted in December. However, we see three risks:
First, households in the US (and other major economies) could use up their savings too quickly, a point recently made by Fed Chair Powell. That said, US household balance sheets are in a relatively healthy state. In the second quarter, US household liquid assets (including deposits, mutual fund and equity holdings) were 3.1 times bigger than total liabilities (mainly mortgages), roughly double the ratio post the 2008 Global Financial Crisis7. Households could potentially use these assets to finance consumer expenditure through this bumpy period.
Second, a sharp acceleration in unemployment could discourage households from spending their savings. The UK’s coronavirus Job Retention Scheme (national furlough scheme), which paid 80% of furloughed employee wages at its maximum, expired at the end of October, but it is now being extended into December during the lockdown. A research house, Capital Economics (CE), estimates that pandemic-related fiscal support will fall to around 5% of GDP in March 2021 from a peak of 20% last May8. With less financial support coming from the government, the risk is that redundancies rise, and consumption growth slows.
Third, the recent rise in new COVID-19 cases across Europe, and the resulting local lockdowns in Spain, France and the UK could undermine consumer confidence, the growth outlook and the ability to spend. Nevertheless, the Eurozone service Purchasing Managers Index (a surveyed proxy of consumption) has dipped only slightly to 46 in October, below the boom/bust threshold of 50, but remains substantially higher than a record low of 12 in April9.
In short, unlike the Global Financial Crisis in 2008 when policy stimulus was largely directed to shore up the balance sheets of the banks (i.e. Wall Street), more money has been directed towards consumers (i.e. Main Street), as evidenced in raised savings rates. Moreover, the latest data shows that US real median incomes are growing by around 1% a year, compared to deep contractions in the previous 3 recessions of -4.4% (2008), -2.1% (2000-01) and -4.5% (1990)10. This data suggests the government handouts have worked to ensure the stimulus has been more equitable, thus increasing the likelihood that consumer pent-up demand will be supported by both savings and incomes. Certainly, the fundamental backdrop for company earnings has improved. Current consensus one year forward global Earnings Per Share annual growth rose to a decade- high of 20%, up from a low of -2% in May11. Given this favourable environment, we remain constructive on equities despite the obvious risks. This includes the uncertainty over the as yet unknown outcome from the US presidential election and a potential disputed result in the courts.
1-4, 6, 9, 10, 11 Refinitiv Datastream, data as at 26 October 2020
5 International Air Transport Association, data as at 28 July 2020
7 Capital Economics, data as at 20 October 2020
8 Bloomberg, data as at 23 October 2020
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
Please remember investment involves risk. The value of investments and the income from them can fall as well as rise and investors may not receive back the original amount invested. Past performance is not a guide to future performance.