January 2021

2021 has started as 2020 ended, in very restricted circumstances. We envisage that 2021 may well be a different year, with many having already changed plans and limited contact. However, the next 'year-end', the tax year end of 05 April 2021, is not cancelled. Indeed, there may well be much to focus on this year, with the Budget planned for 03 March 2021.

As we have in the past in this important section of our website, we have sought the views of our investment consultant, Steve Williams, director of Cormorant Capital Strategies for his forward view. His notes are below:

Domestic UK Economy

The most recent analysis from the Office for National Statistics characterises a decline in output of something like 2.6 percent during November to leave total gross domestic product (GDP) at a level which is 8.5 percent lower than it was in February 2020. It remains to be seen how hard the tiered/local lockdowns have impacted economic activity during December 2020, however my guess is that we will see a calendar year loss in the region of 10.5 percent. That is far higher than anything we've seen in the modern record.

UK employment levels are likely to fall too. The official data reveals that the number of payroll employees has fallen by 819,000 since the onset of the pandemic. The three months to October saw a record number of redundancies. The unemployment rate stood at 4.9 percent over the same three-month period, compared with 4.0 percent at the start of the year. My best guess is that unemployment will rise to 5.2 percent by the time we have the data for the full year.

The immediate outlook is no less bleak. Restrictions on economic activity will last into the spring 2021.

The first quarter (Q1) of this year (2021) will likely bring about a further decline in output, perhaps in the region of 2.3 percent. I'm not sure at all when we will see the peak rate of unemployment but I'm guessing it comes early in the year, perhaps late in Q1.

Beginning in spring, though, I expect the outlook to brighten in line with the longer days and I'm hopeful of rapid gains as we head into the summer months. So much so that I think the British economy might harvest an increase of something like 4.5 percent for the year as a whole.

My optimism is founded on three observations. The first, and most important, of the three is that the capital markets and the banking system are functioning well. That means that healthy businesses (and, to a lesser extent, consumers too) have access to money to fund short-term requirements and to fund expanded operations as and when the time is right. In other words, there is no reason to expect anything other than a vigorous recovery when the current restrictions on economic activity are lifted.

My second observation captures the various forms of stimulus – both monetary (being the remit of the Bank of England) and fiscal (HM Treasury). Neither aspect has been lacking. I have been a critic of both the Bank of England and the Treasury in the past, but I am impressed with their handling of the crisis.

The third of my observations is perhaps the one that will have the greatest impact on timing. We will escape the pandemic a little earlier or a little later depending on how quickly we can progress the vaccination programme. There is no reason to believe that the vaccines we now have at our disposal will not be effective against this virus – in any of its many variations – and, with the British Army spearheading logistical efforts – I'm more confident that it will be delivered at pace.

UK Interest Rates

During the December 2020 meeting of the Monetary Policy Committee (MPC), policy makers at the Bank of England voted unanimously to maintain Bank Rate at 0.1%. The Committee also voted to maintain the target for asset purchases at £895 billion, comprising £875 billion in government bonds and £20 billion in investment grade corporate bonds.

I don't expect either of those decisions to be revisited when the MPC next meets on 4th February 2021. Indeed, I don't expect those decisions to be revisited at all this year. And, if my calculations are accurate, bond market participants are minded to agree with me. Indeed, prices in the bond market are consistent with Bank Rate remaining at the current level for as long as two years from now. Of course, that time horizon will fluctuate in line with economic conditions and a lot can change between now and then. But there is little doubt that ultra-low interest rates are expected to last.

My expectations for the Bank Rate to remain at 0.1 percent are contrary to recent speculation that the Bank might force rates lower still, perhaps into negative territory. Indeed, I think that course of action would have support from at least one member of the Monetary Policy Committee. Further stimulus is likely only required in the event of a significant deterioration in the outlook. It is my contention that, in those circumstances, the Bank will first expand its asset purchase programme. £895 billion is a large number, but the market for gilts is bigger still. There is room for the asset purchase programme to be expanded further if necessary.

In any case, even allowing for a slightly negative policy rate, it is very unlikely indeed that retail deposits would suffer negative rates too.

UK Inflation

The Consumer Price Index (CPI) increased at a year-on-year rate of 0.6 percent during December 2020, well below the 2.0 percent target. Core inflation (CPI excluding energy, food and alcohol) is running at 1.4 percent. I expect headline inflation to close the gap and eventually exceed core inflation as it trends back to target around the close of this year.

I am conscious that a number of investors remain concerned that today's stimulus – both fiscal and monetary – might encourage high inflation in the long-run. That is a risk I am alive to and I remain vigilant. My best guess, at this time, is that inflation remains reasonably well-behaved.

Global Economy

The economic restrictions associated with the pandemic brought about a global contraction only surpassed in scale by the Great Depression, Great War and World War II. Fortunately, it is likely that the global economy is growing again.

Following a decline estimated to be around 4.3 percent in 2020, the World Bank expects the global economy to expand by 4.0 percent during 2021. Growth will be shared unequally with the developed market economies lagging those of the emerging and developing market economies with gains of 3.3 percent and 5.0 percent respectively. I see no reason to deviate from those expectations.

In President Biden's first year of office, the US is expected to grow at 3.5 percent, a little behind the Euro Area's gain of 3.6 percent. Meanwhile Japan's economy will increase 2.5 percent. Assuming those gains do materialise, it is unlikely that the losses associated with the pandemic will be fully made up; further gains in 2023 will be required for that to be so. The good news is that the World Bank is projecting just that. 2023 is expected to see even stronger rates of growth in the Euro Area (4.0 percent) and sustained high rates in the US (3.3 percent) and Japan (2.3 percent).

Among the emerging markets, the BRIC economies of Brazil, Russia, India and China are expected to fare particularly well – aggregate growth of 6.1 percent is penciled in for the year ahead. That figure too is swelled by the extraordinary performance of the Chinese economy which is forecast to bounce 7.9 percent higher. Growth in Brazil will amount to 3.0 percent with India and Russia gaining 5.4 percent and 2.6 percent respectively.

Of course, each of these numbers ought to be regarded with a degree of scepticism. The single biggest determinant for success, or otherwise, will be the course that the virus takes. There is a considerable degree of uncertainty in that regard. Risks to the downside, highlighted by the World Bank, include a re-accelerated infection rate, delays in vaccine rollouts, a longer 'shadow of fear' suppressing normal behaviour, and surging debt – the latter elevating the risk of further crises in the global financial system.

The notes above are only views and no individual views or guidance is provided. With these points made, we remain optimistic for growth and returns in 2021, although the successful roll out of various vaccines are likely to play a significant factor in our overall return to 'normal', whatever that now is!

Keith Churchouse FPFS


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