Global equities slipped back 1% last week, reversing some of their recent gains. UK equities also gave back some of the previous week’s outperformance. Both moves, however, pale into insignificance compared to those seen in recent months.
The US was once again the focus of attention. And once again the market’s focus was rather different from the news headlines which were dominated by the House of Representatives voting to impeach Donald Trump for the second time – a first for a US President. With Trump already out of office before his forthcoming trial in the Senate gets underway, this has minimal implications for policy, other than being a major distraction. A conviction, however, could lead to Trump being barred from running for office again.
Much more important for the markets were President-elect Biden’s plans for another hefty fiscal stimulus totalling $1.9trn or 8.5% of GDP. This comes on top of the $950bn package approved only two weeks ago. It is very much Biden’s opening gambit and the wafer-thin majority of the Democrats in Congress means the stimulus will probably be cut back to around $1trn. Even so, these are still big numbers and fiscal policy is set to be a major support for the economy over the coming year.
With the US economy still the second largest in the world, this will also provide a significant boost to the global recovery. Still, China is top dog these days and this morning’s numbers only confirmed how comparatively well its economy fared last year. Chinese GDP was 6.5% higher in the fourth quarter than a year earlier. This left growth positive for 2020 overall in contrast to the marked declines set to be seen in most other countries.
The difference in performance has been particularly extreme versus the UK, one of the countries worst hit by Covid. Last week’s report showed UK GDP contracting a smaller than expected 2.6% in November. But it remained as much as 8.5% below its pre-Covid level and the current lockdown means GDP is bound to contract further in the first quarter.
The silver lining, if there is one, is that the UK should see a burst of strong growth from the second quarter onwards. The vaccine roll-out is proceeding more swiftly than in most other countries and the scale of last year’s decline in activity means the catch-up potential is all the greater. That said, fiscal support is of a rather different magnitude to the US. The furlough scheme is due to end in April and the Government is resisting pressure to extend the Covid-boost to Universal Credit.
Returning to the markets, we believe prospects for equities look considerably better than for bonds even after the scale of the gains already seen. A vigorous global rebound should drive strong growth in corporate earnings later this year which should allow equities to see further increases. Corporate bonds, by contrast, will suffer both from the very low starting level of yields and the drag on returns coming from the upward trend in government bond yields.
Last week, we said the most obvious risk to this benign picture for equities came from the virus. While this is true for the coming year, further out another risk lurks which is already causing monetarist economists to tear their hair out. This is the threat of a surge in inflation on the back of the massive monetary and fiscal stimulus.
Opinions vary wildly and the outcome will be critical in determining the outlook for markets over the next few years. A few words, or even sentences for that matter, will not do the matter justice and we plan to address where we stand on this vexed issue in more detail over the next couple of weeks.
Rupert Thompson
Chief Investment Officer