While sitting at my desk one afternoon this week, I bought a recipe book, two jumpers, six pairs of socks, a Japanese tool bag, three sheets of Christmas window stickers and a fake rattan garden sculpture of a hare (light up). I am the very personification of something I have long insisted cannot exist – pent-up demand.
In usual circumstances there is rarely such a phenomenon as pent-up demand in the economy: if you want something and you can afford to buy it, there is demand for that thing; if you want something but cannot afford to pay for it, there is no demand for that thing. There might be elements of longing and hope, but not actual demand.
Today, things are a bit different. People’s finances are, in the main, pretty good. Bank of England statistics from August show that while 28% of people have found that their incomes have fallen during the pandemic (mostly as a result of furlough), 57% have found that their spending has decreased. The financial situation has improved even more for the economically inactive, such as pensioners – 90% have seen their income stay flat, while 60% have seen their expenses fall.
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While those who have lost their jobs have suffered, those who have not – the great majority – have seen their cash piles grow, bringing a sharp rise in household savings. The same is the case in the US, where bank deposits have soared to create what Federal Reserve vice-chair Richard Clarida is calling “an enormous quantity of pent-up saving”.
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Lockdown isn’t stopping us from spending on things (witness my splurge) and you can see that in the numbers. House prices are growing fast in the US and in the UK. Retail sales in both countries have recovered after the plunges seen in the spring and were up last month, by 4.9% year-on-year in the UK and 5.7% in the US.
But the pandemic restrictions have prevented us spending on services and on things that we prefer to buy in physical shops. That may be where the real pent-up demand is. We want services and stuff that we buy in stores – we can afford them, but we aren’t able to buy them.
What happens when this pent-up demand is let loose?
This is why the good news on vaccines is so important to investors. We now know that vaccines work and that they will be available soon – in a matter of weeks, according to some more optimistic reports.
You can chuck as much misery grit into these stories of scientific brilliance as you like (they aren’t approved yet, the logistics are too hard, health insurers might not cover them in the US, the volunteer samples are too small, etc) but the fact that vaccination of the most vulnerable at least is near does allow us to ask the question: what happens when this pent-up demand is let loose? What happens when the kind of person so desperate for an out-of-the-house experience of any kind that she will buy a fake rattan garden sculpture of a hare (light up) gets her hands-on freedom, a passport and access to a travel agent?
Capital Economics suggests that Spain’s tourist industry could do even better next year than it did in 2019 as we all take our catch-up holidays. I’ll buy that as a forecast. When we can, we’ll all be out and we will all be spending. The same goes for business travel – the consensus is that there will be less of it for many years. Bill Gates reckons that 50% will never come back, as in-person meetings are no longer the “gold standard” of communication. He may be right, but I’m already hearing companies talking about how their people will be travelling much more than usual next year: Gates’s standards aren’t necessarily the same as everyone else’s.
From an investor point of view the response seems obvious: sell Covid winners and buy Covid losers. That is exactly what has been happening: hospitality and travel stocks went berserk the day the first vaccine news was announced, and if you look at the sector performance for November so far you will get the picture. In the US, the energy sector is up 25%, financials are up 15%, casinos and gaming are up 24% and carmakers 21%.
It’s not just a “reopening trade”
But this isn’t just about a little vaccine joy and what you might call the “reopening trade”. It might also mark the beginning of what analysts call the reflation or the rotation trade – based on the idea that a shift in inflation expectations (a huge amount of money is being printed and handed directly to consumers – and that money is starting to move) is triggering a shift from growth stocks, where you buy earnings you might get in the future, to value stocks – where you buy earnings which already exist or – in the case of these Covid days – will exist again in the spring.
Growth has firmly trumped value in equities both for the past four years straight and in 14 of the years since 2000, says JPMorgan Cazenove. The 33% difference in the performance of the two strategies over the year so far is the largest on record. The gap between the valuation of the two kinds of equities in both price/earnings and price/book ratios is very large.
There is a huge mispricing here – and one that makes no sense as economies reopen, new stimulus is released, growth surprises on the upside and inflation risks rise.
So what do you do? This is the environment in which the big technology stocks will finally underperform. You don’t want to get rid of them completely (some trends accelerated by Covid will at least in part stay with us) but you might want to trim them back. However, it is a market in which financials should benefit (they gain from the rising bond yields that come with increasing inflation expectations) as should airlines, travel operators and retailers.
And there is more. As James Ferguson of Macrostrategy says, the “most exciting opportunity of the moment is in commodities. They’ll give you portfolio insurance against inflation (you need this). But they are also generationally cheap: just to return to their long-term price trend relative to global equities, a basket of commodities would have to outperform equities “almost fivefold”. It’s time to buy them. Then you can sit back and think of your spring trip to Spain.
