During Q4 2020, two major political events that were overhanging markets, Brexit and the US election came to pass. In contrast, there has been little in the way of political developments. The Biden administration started progressing with the spending pledge with the $1.9bn stimulus being approved in March. This was larger than expectations and broadly included the full with a list of spending promises. We are also beginning to see how the new administration is engaging in some of the major geopolitical areas. Elsewhere, increasing noise around Iranian nuclear development also suggests that there may be the potential for change there, which would have implications for oil in particular. For the UK, any progress on a trade deal with the US would likely produce a significant lift, although there are yet to be any tangible developments as nations currently work down their own priority lists.
In China, the latest 5-year plan has been published suggesting that the manufacturing powerhouse is looking to move up the value chain and focus increasingly on high-tech manufacturing. The plan omits a commitment to a GDP growth target signaling that the focus may be increasingly on productivity and environmental goals. The plan also notes that domestically driven demand and innovation are needed as a defense against Western decoupling from China. The nation of nearly 1.4bn people will face an increasing demographic headwind over the coming years as the implications of the one-child policy and aging society take their toll. A shrinking workforce will place the burden on productivity gains to drive top-level growth, something that the central government is increasingly conscious of.
Foreign Exchange Movements
While we are not looking to anticipate FX movements, it is important to consider their impact on portfolios and the risk involved with potential movements. The key mover in the quarter has been the pound, which posted leading returns across developed market currencies, reaching levels in some cases not seen since the Brexit referendum in 2016. As portfolios have a bias towards UK equities, as well as fixed income and alternatives allocation, being Sterling-based, this appreciation has had a positive relative impact over the quarter, reversing some of the previous headwinds.
While at the beginning of the quarter the absolute level of infection globally was high, the last three months have seen an Improving picture, and the market is increasingly focused on the vaccine rollout and its effectiveness at reducing the spread, hospitalisation, and death. Although not without obstacles, the quarter has seen largely positive developments and the focus is now on how quickly economies reopen. Increasing infections are not a thing of the past, with several countries in Europe seeing rising rates once more, even during the vaccine rollout.
As has been the case since the start of the pandemic, risks to markets come from the direct impact of COVID as well as more significantly, government reaction to developments. Investors have therefore been increasingly focused on how quickly governments are willing to ease restrictions. There is now a clear pathway to a broadly unencumbered economy. The timeline across regions follows the path of a completed vaccination programme, meaning that key regions should see rapid returns to normality during the second half of 2021.
The key risk going forwards is the development of variants that may be more infectious, more deadly, and/or mutations that make the current vaccines less effective. While vaccine manufacturers have provided assurances that adapted versions can be quickly created to combat any new varients, clearly there may be a lag to the full deployment of these. Governments may be willing to impose restrictions once more during such events.
Overall, the world now has the tools to manage COVID and although it is unlikely to disappear, vaccines and early identification of new variants should limit its impact to the extent that countries are willing to live with it, as the case with many other causes of death. However, with the increasing populations living in more dense cities and greater connectivity, the prospect of additional pandemics going forwards is a clear risk.
The growth rate released over the quarter unsurprisingly showed that the government restrictions over Christmas have led to contraction inactivity. However, on average, the damage has been less severe than feared, and analysts are ever more focussed on the second half of the year when economies begin to reopen. Current data is difficult to interpret and unreliable as a tool to measure the health of the economy. Forced restriction of activity does not reflect the desire and ability of individuals and companies to spend and invest.
Indeed, there are good reasons to believe that there will not only be a rebound to normalised levels but an element of catch-up spending from consumers, potentially leading to a surge in investment from companies, driving higher rates of growth. Add on to this continuing fiscal expansion. How long such a positive feedback look can persist may be the key debate over the coming quarters. Globally, consumers have built up excess savings to the magnitude of trillions of dollars, held back from spending it not from desire but by restriction.
Below is the US unemployment monitor that we have included previously. The official rate of unemployment is now 6.3% (January 2021) down from 14% in April. Furthermore, there has been a continued recovery in US employment over the quarter, having reached a low in April/May. However, there is still a shortfall of 4m in the total labour market, implying that inactivity is also an issue. Some have suggested that the ending of the furlough and unemployment allowances will lead to this unwind but effects such as early retirees etc. Maybe more persistent. The implications of this are that the US may reach “full employment” earlier as there is less slack in the labour market. Therefore, the risks for higher underlying inflation are higher in the US, as companies are forced to compete for labour in a booming economy.