April 2021 Insights

Enjoy the Post-Lockdown Bounce, But Bear in Mind: Risks are Building Under the Surface

As the UK finally begins to open up things are inevitably going to get better, at least in the short to mid-term, and there is no denying, it is about time. The UK has suffered Europe’s highest death toll from Covid. Last year it went through its worst economic slump in three centuries after shrinking by 10%. But the country is racing ahead with vaccinations and economists now expect the economy to contract 2% in the first quarter of 2021, half the hit forecast by the BoE only last month.

We have decided to dedicate this edition of our bimonthly newsletter to the rays of hope – which for convenience sake we have abbreviated to “ROH” – that are finally beginning to shine through as the UK starts to emerge, bleary eyed but full of beans, from its third lockdown of the last 12 months. But as we will remind you in the final section, we are still in the midst of the worst period of economic disruption of our lifetime and financial market risks continue to build under the surface.

ROH# 1: Getting on with Brexit

Let’s be honest – if we were not in year 2 of Covid-19 and if the UK media were not devoting most of its coverage to the impressive rollout statistics of the vaccination program, far more attention would be paid to the fallout of Brexit. Instead of reeling at the 40% drop in exports to Germany in January, or the ongoing struggles of certain sectors, we are focusing ahead on the end of this lockdown and scrolling through summer holiday breaks in Greece.

The excellent vaccine program has not only shown that this government can get some things right during this pandemic, it has underscored one of the most important benefits of Brexit: it has given the UK greater independence of action. Unmoored from the EU’s much more bureaucratic governance machine, the UK is now able to move faster to leverage opportunities or mitigate threats. Even more importantly, this has helped persuade a large number of former Remainers that Brexit may have certain positives, although it of course still very early days.

ROH#2: Big opportunities amid the disruption

While Brexit and Covid-19 certainly make for strange bedfellows, they do have one thing in common: both of them require the UK to readjust to a new reality and at pace. The pandemic has hugely accelerated the move to online shopping, with the gradual increases expected over the next five years shoehorned into just the last 12 months. In addition, working from home was already on the agendas of many companies. But again a slow, incremental change was predicted, not the mad stampede out of Canary Wharf and other office hubs that we have seen.

Covid’s effect on the economy has been dramatic and unparalleled but some of the disruption it has engendered may lead to positive outcomes – rethinks, restructuring, realignments. Maybe we have to ask ourselves: are we seeking to turn the clock back a couple of years and return to what was then a less-than-perfect normality, or do we accept it is a different ballgame and embrace the changes already created? Falling back on the great British virtue of pragmatism, we can move forward with renewed faith in our ability to face up to huge challenges (e.g. climate change) on a macro level while being prepared to think outside the box in making micro-level improvements.

ROH#3: Reimagining the economy

One of the biggest opportunities created by the Covid-19 pandemic is the opportunity to reimagine how the economy works. Bricks-and-mortar retail offers an interesting case in point. The lockdowns were the final straw for many long-struggling chains, including Debenhams, Top Shop, HMV and a host of eateries. Their demise has left gaping holes in the British high street. But the government-funded Future High Street Fund is already pouring money into redevelopment. For the first time in decades, the UK high street is about to get a much-needed makeover.

Earmarked for purchase by many city councils are scores of 1970s eyesores, some to be transformed into apartments. For example, retail landlord Hammerson has submitted a planning application to turn a former Debenhams department store in Leicester into 300 homes. In the middle England city of Worcester, the building once occupied by Debenhams has been sold to Hammonds of Hull, which plans to create a complex of artisan food halls and organic farmers markets modeled on the one already established in Hull.

Many of the new changes on the high street involve independent companies rather than chain stores. This suggests we could be about to see a welcome departure from the sameness and blandness of city centres dominated by the Arcadia Group and other chains.

Away from the high street in search of the proverbial green shoots, we could start by looking again at the combination of Brexit and Covid on our infrastructure. Sourcing automotive component parts was causing UK companies to look to UK manufacturers rather than rely on their EU counterparts. Covid and the further disruption to supply chains will have propelled more companies down this route, creating more opportunities for growth in the UK economy and the creation of more jobs.

While the picture is far less clear in other industries such as aviation, the UK has the potential to surge forward in areas linked to green energy. With Cop 26 being hosted by Glasgow in early November, the world’s eyes will be on the UK at a time when it is second only to Germany as the European poster boy of renewable energy use.

ROH#4: People are ready to spend. Some have money to burn

One of the more bizarre aspects of the current crisis is the bifurcated impact it has had on household finances. Many people have lost their jobs, or businesses and have seen their incomes dry up as a direct result of the lockdowns, while those who have held onto their jobs and been able to work from home, or enjoy generous pensions, may well have seen their savings explode. Those savings can now be put to good use.

The Bank of England estimates that £250bn is currently sitting untapped in personal and household savings accounts. In the coming months, much of that money is likely to flow from bank vaults, where it is earning virtually no interest, into the retail, leisure and hospitality industries that desperately need it.

And people seem ready to spend. GfK’s consumer-confidence barometer rose seven points from the previous month to register its highest reading since the coronavirus pandemic crippled sentiment. Most importantly, Britons were more upbeat about their personal finances for the year ahead, up seven points to 10, a three-year high. The major purchase index, which gauges demand among shoppers, increased by eight points.

“If this improved mood translates into spending, it might help reverse some of the economic damage the U.K. has suffered,” GfK’s client strategy director Joe Staton said.

But let’s not get carried away…

There is clearly cause for optimism for the months ahead. But as the country begins to reopen and we begin to return to some semblance of normality – albeit one that is likely to include continued mask wearing, social distancing, vaccine passports and the ever-looming threat of another lockdown – it is important to keep in mind that we are still living through the most tumultuous crisis of our lifetime. Big economic and financial risks and pressures are building. Some have already come to the boil.

In recent weeks we have seen the collapse of the UK-based supply chain finance company Greensill, as well as the hugely levered hedge fund Archegos Capital, both of which have left banks and investors bearing significant losses. In the case of Greensill, its demise could spark the collapse of steel tycoon Sanjeev Gupta’s GFG Alliance, which owns companies all over the world including in the UK. While neither collapse is anywhere close to the scale or import of Lehman Brothers’, they still serve as a reminder that fragility and risk have continued to grow as leverage has mushroomed.

These problems long predate the virus crisis. And that crisis is still with us. Despite the hundreds of billions of pounds of government and central bank stimulus, thousands of businesses have already hit the wall and hundreds of thousands of people have lost their jobs. The investment environment still remains acutely uncertain. There is also the prospect of inflation rearing its ugly head for the first time in decades. After so many years of financial repression from the central banks, we are not used to investing in times of inflation, if indeed this does emerge.

Perhaps the crux of the issue is whether governments and central banks can use additional debt to mitigate problems which have exacerbated what were already unprecedented levels of debt from a world economic perspective? We will only know this with the benefit of hindsight.

In Conclusion

Perhaps it is still too early for firm conclusions to be drawn. Recovery is ongoing and it is important to monitor how developments unfold.

Please do let us know if you have any queries in relation to the issues raised in this newsletter and how they relate to your own investment portfolios.