Stephen Jones: 'Given the poor visibility into the future, it is perhaps best to think about our own behaviour'

Comparisons between the Covid shock and the Spanish Flu pandemic abound; less often mentioned is the Hong Kong flu of 1968/69. Also with its origins in China, the Hong Kong flu led to the deaths of 80,000 people in the UK (one million worldwide). It is worth remembering that its peak impact spanned two winters, and it continues to circulate as a seasonal flu today. Covid-19 is unlikely to be here today, gone tomorrow. Unlike 1968/69 when perhaps most were blissfully ignorant of the harsh realities of serious infection, our digital age denies us that ignorance and locking down economies may become the norm.

Regardless, it is our nature to believe that harsh times will not last, and that things will soon get better; that was certainly the perspective adopted by most in the depth of the Global Financial Crisis. Optimism around an early return to normal this year should be tempered by the realisation that normalisation from the Credit Crunch has yet to happen. For investors nowhere is this more so than in bond markets where the average yield on 30-year gilts over the decade before the GFC of 4.5% has now surely been consigned to history (the post-GFC average has been 2.6%). With discussion beginning around the prospect of Central Banks fixing long term bond yields at ultra-low, near-zero, levels (Bank of Japan-style), the uncomfortable truth for beleaguered pension funds is that they are not going to find relief from the higher discount rates of yesteryear.

After every major shock, market actors become fixated about the shape of the economic profile that awaits; V, W, U, L or (reverse) √ -shaped or some other. In almost all these scenarios, the initial sense is that the recovery will be V-shaped until time proves otherwise. This is particularly true when most of the leading indicators are sentiment based, thus capturing the emotional extremes of those surveyed as the swing from euphoria to despair. This is the position today. Emboldened by the powerful (and relative to the GFC) quick monetary and fiscal policy response, and, to a great extent, short of somewhere else to put their cash, investors are chasing equities higher. This will work until it doesn’t.

Given the poor visibility into the future, it is perhaps best to think about our own behaviour. For how long will we remain crowd averse? When will travellers to London next be happy to pack, as sardines, nose-to-armpit, into the London Tube? Fancy a cruise with a bunch of elderly folks any time soon? The weather during the lock-down has been good. Faced with the prospect of queuing outside in the rain, how many will decide against that must-have purchase? History shows that, post pandemics, individuals increase their prudential saving; will we all feel that we would be better having a little more tucked away for a rainy day? All these questions challenge hopes for a swift and sustained rebound.

The plethora of official inquiries that await will inevitably conclude that for a sharply increased list of national priorities, complicated global supply chains need to be replaced by ‘made here’. Pressure to increase self-sufficiency, as Governments seek to rebuild employment, will surely prove irresistible even if it means that prices rise; indeed, many now think that a little bit of inflation would do no harm. Shortening supply chains also meshes well with demands to reduce our carbon footprint. These issues, and doubtless many more, point to a world different to that of three months ago.

Finally, profound changes are needed. Analysis by Deutsche Bank of the crises of the past forty years, highlights that each one has increased debt relative to the real economy and successive crises have required successively bigger bailouts. The scale of the cash spent on the Covid suppression has gone beyond telephone numbers; predictions abound that the US Federal Reserve’s balance sheet will balloon to at least $15 trillion. Another crisis is as certain as rain during the Glasgow Fair. Perhaps the biggest question of all we face is, what do we do next time?

Stephen Jones is chief investment officer at Kames Capital.