In this week’s market update: investors look beyond Covid as the chance of a vaccine rises; Brexit talks come down to the wire; and Rishi Sunak’s spells out his spending priorities.
Markets have settled into a tight range, holding onto recent gains, as investors weigh up the worsening Covid and related economic backdrop with the increasing promise that a vaccine might soon set us back on a path to normality.
Overnight shares also rose in response to Donald Trump’s grudging acceptance that his time in the White House is ending. He instructed officials to co-operate with the incoming Biden team although he stopped short of actually conceding the election. Shares in Japan rose 2.4% after a long weekend break.
The last few weeks have been driven by sentiment shifts from pandemic gloom to re-opening optimism and back again. In recent days the picture has become more fragmented and stock specific as the two narratives have slugged it out for dominance, but the mood has turned decisively more positive today.
This week started with a battle royal between the two stories. The good news was provided by AstraZeneca and Oxford University, which had been the leaders in the race for a vaccine until Pfizer and Moderna came up on the rails a couple of weeks back. Now the UK team is back in the race after trial results emerged with up to 90% efficacy, in line with their American rivals.
The good vaccine news makes a widespread jab look increasingly likely with a few months. Which in turn makes a return to some kind of normality by next summer look plausible. A fall in the shares of protective equipment manufacturers in China are the clearest indicator of the new mood of positivity. It supplies 44% of global PPE equipment.
Other than for that niche, the market responded positively to the news, although investors have quickly moved on from the near hysterical relief rally that greeted Pfizer’s announcement two weeks ago. Things are a bit more cautious today.
And rightly so because we are clearly not out of the woods from the perspective of infections and hospitalisations, particularly in the US, or economically across much of the world but particularly here in Europe.
Evidence for that came this week in the form of purchasing managers index announcements across Europe and the UK. They showed a region reeling from the impact of the second lockdown and heading towards a double dip recession as the optimism of the summer has been replaced by a resigned acceptance of new stay at home orders.
Here in the UK, the impact of lockdown was felt most keenly in the all-important service sector, which accounts for 80% of the UK economy and saw the PMI fall from 51.4 to 45.8. That was a bit better than forecast but still well below the 50 level which separates expansion from contraction.
And the outlook for the hospitality sector has certainly not improved following yesterday’s announcement of continuing restrictions on pubs and restaurants under the restored tier system that will replace the current national lockdown from 3 December.
Under the new rules, two of three tiers will see pubs and restaurants restricted to two members of one household or limited to takeaways only. The rules will last until March, effectively a new framework for the whole of the winter.
Manufacturing actually continues to grow but these days it’s a relatively unimportant part of the British economy. UK Plc can’t fire on all cylinders if the ‘non-essential’ parts of the economy like pubs and restaurants, are closed or restricted.
The performance of the stock market against this backdrop might seem a bit puzzling but it is quite normal. Markets are discounting mechanisms. They focus more on what is going to happen next year than what is going on today and the vaccine stories suggest that 2021 is going to be a whole lot better than 2020 has been.
Stock markets went into a sideways moving pattern in September and in technical terms have now broken out from a narrowing triangular shape to the upside. This again is normal. Markets that pause for breath as they have over the past two months do more often than not revert to their previous direction of travel, which as we know has been upwards since the spring.
The good news is that the gains have happened in the absence of much real enthusiasm from investors in terms of fund flows. This remains an unloved bull market and that suggests that it could still have a way to run as there is still money on the side-lines waiting to be put to work.
If you look at the longer run bull market in the context of earlier so-called secular or multi-year rallies, then a good case can be made that the current rising trend remains intact. Although shares have been rising for 11 years now since they bottomed in 2009, this does not look excessive when compared with previous up trends in the 1980s and 1990s and before that in the 1950s and 1960s. In both cases shares rose for around 20 years.
Indeed, it is uncanny how closely the last 11 years mirror the market performance of the first half of both of those earlier extended bull markets. But that doesn’t mean that it will simply be more of the same for the next 11 years. In previous long market rallies the leadership often shifted around half-way through.
For example, in both previous bull markets, commodities started to outperform stocks at around this stage. That could be replicated again, especially if big expansions of government spending trigger a cyclical upturn in the economy, especially one fuelled by infrastructure spending and one characterised by rising inflation. The oil price rose again yesterday to more than $46 a barrel on greater optimism. Gold, on the other hand fell again to $1,825 an ounce, well off its recent peak.
Inflation was actually the key difference between the two earlier bull markets. The first ended in the high inflation 1970s while the second in the low inflation noughties. We’ve talked a lot here in recent weeks about the style shift from growth to value and whether this actually happens now is dependent in large part on whether inflation returns.
Credit Suisse recently listed five reasons why an upwards price spiral might be on the cards again. It thinks that government policy is shifting in an inflationary direction with the abandonment of austerity as a political philosophy and its replacement with a mantra of borrow cheaply, build back better and let the future take care of itself.
The second driver of inflation is money supply, with central banks printing money like there is no tomorrow. All that extra liquidity looks certain to leak into prices at some point.
The third key factor is the reversal of many of the disinflationary forces that have dominated the past 30 years. The retreat of globalisation and the reshoring of jobs is the most obvious of these.
Inflation driver number four is demographics. The proportion of people born after 1980 will soon be greater than those born before that date. And those millennials are rightly annoyed that they have missed out on the financial bonanza of rising house prices and free education that their parents enjoyed. Government policy is going to shift towards their interests and that means, among other things, higher wages.
The final reason to think that inflation is on the way is perhaps the most powerful. It is that governments which have racked up enormous debts first in the financial crisis and now in the pandemic only really have three options to deal with that burden: default, austerity or inflation. The first is inconceivable in a developed economy. The second is now politically impossible. Inflation is the only way out and that makes it inevitable at some point.
That is the backdrop to Rishi Sunak’s spending review this week, replacing an abandoned budget and limited to just one year’s spending plans. It will nevertheless be a fascinating picture of post-pandemic Britain, saddled with debts not seen ever in peacetime and rarely in time of war.
The public finances are one headache for the government. Another is Brexit, which is finally approaching crunch time. Although we have said this before, it does look like this week really is the last opportunity to strike a trade deal with the EU and have it signed and sealed by the time the shutters come down on our current trading arrangements on New Year’s Eve.
Both sides are playing hard-ball, at least in public, but it is in no-one’s interests to allow the clock to tick down at the end of the year. We should expect some compromises on both sides this week. And let’s hope we get them. A no deal exit has been calculated to cost the UK economy 8% over 15 years. That is a significant reduction in everyone’s wealth and surely still avoidable.
So, what happens next? On the EU side there is acceptance that ratifying the deal becomes difficult if it is not agreed by the end of the month. In other words, next Monday. At the very least, any text needs to be thoroughly checked for errors and unforeseen legal consequences - scrubbing, in the jargon.
Then the European Parliament needs to sign off on any deal. There is one more session in mid-December but it is possible that a further session has to be scheduled even closer to the end of the year. Anyone who has watched previous European negotiations must think this is a very real possibility.