New article from Tatton Investment Management: December concerns over baubles and bubbles

4 December 2020

As the world faces up to a not-so-jolly Christmas season, it may be surprising to learn that sentiment across the global economy was reported to be quite strong this week. Admittedly, this is mostly driven by strong manufacturing data and not the services sector, which relies so much more on social proximity. Nevertheless, the current economic environment combined with the announcement of COVID vaccinations becoming an imminent reality (if only for those vulnerable) had markets starting December on an upbeat note. Following the exceptionally strong investment returns in November, it would unrealistic to expect 2020 to close on a traditional ‘Santa Rally’. However, if the European Union (EU) and Britain are able to sort out their political – but not economically relevant – differences over fish, state aid and the governance of the envisaged Brexit deal, then at least the UK stock market could be in for another pre-Christmas upwards bounce.

At the time of writing, there was plenty of ‘theatrical noise’ emerging from Brexit negotiations, but no sign of the white smoke that businesses on either side of the Channel are so much wanting to see. Persistent rumours reached us that an agreement was imminent, but unlikely before the stock market close, which stores up some volatility for Monday morning.

In the absence of a Brexit breakthrough, the news that Britain had become the first country to officially approve the BioNTech/Pfizer vaccine catapulted the UK into the international headlines. Some bragging comments from government politicians evidenced the distinct lack of diplomatic sensitivity of this crop of political leaders, especially since this specific vaccine was not developed by UK scientists. Different national medical bodies are following their own strategies to ensure the wider public’s trust in the vaccine. It appears unlikely that longer scrutinising of data – which has now been available for weeks – will offer any further insight about potential longer-term side-effects (only time will tell), but more haste and less speed may perhaps persuade some citizens to feel more confident in the national vaccination process.

For the UK, what counted was the start of vaccinations as soon as possible, not surprising given Professor Van-Tam’s statement that the vaccination of just priority groups (see our UK article) would lead to a 99% reduction in fatalities. The sooner the vulnerable and elderly have the COVID jab, the sooner the wider public can return to a much less restricted life.

The strong rebound of UK equities over November had, in our view, not much to do with hopes for a Brexit deal, but much more the prospect that vaccines will lead to a strong cyclical rebound of economic activity. Everybody will be keen to make up for what was missed during the annus horribilis of 2020. This plays to the more cyclical nature of the UK stock markets, heavy with energy, resource and bank stocks, all of whom are highly cyclically sensitive.

This cyclical theme was further enforced during the week. With the US Congress looking increasingly likely to pass an extension of the previously so successful COVID unemployment support programmes – and in anticipation of a broader recovery – oil and commodity prices rose on expectations of higher 2021 demand. This led also to a rise in long maturity bond yields, which was particularly good news for banks. The relative strength of cyclicals, which are more reflective of non-US economies and stock markets, saw capital outflows from the US which increased the downward pressure on the US dollar. Dollar weakness, as we have commented here before, is increasingly linked to accelerating world trade, improving financial conditions worldwide and, as a result, can constitute a formidable growth stimulus around the world.

While this easing of financial conditions tends to encourage central banks to raise interest rates (or at least reduce their current monetary support measures) that particular outcome looks unlikely This means global money supply takes another leg up, just as growth starts to be solid. Should this play out as it usually does, then over the next few months, the term ‘bubble’ may no longer just apply to the people in your house.

While this year’s pre-Christmas season may look distinctly bleak, markets are certainly looking through the extension of partial lockdowns to January (Germany) and the extension of other restrictive measures (UK). But what might go wrong for markets against such a bullish scenario? Well, if central banks decided to step back from their previous promises to kept yields low and buy as many bonds as necessary to make this happen, then a rapid increase in yields could sour market sentiment very quickly as the positive scenario begins to quickly evaporate. Not a very likely scenario, but some tightening may be on the cards should economic and market conditions turn ‘bubbly’ too quickly in 2021.

News Archive

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