Reasons for investors to be cheerful

Markets are betting on a V-shaped recovery – and recent data suggests that they may be right.

The two biggest uncertainties facing investors are when we will have an effective vaccine or treatment for Covid-19 and whether the economic recovery will be V-shaped or resemble some other increasingly contorted letter of the alphabet. Although these questions are obviously related, they are not entirely the same. The world will not get back to normal until the coronavirus is no longer a major problem, either because we’ve solved it medically or because enough people have caught it and got over it. But the scale of the economic shutdown that we’ve seen in the last few months is so great that unless activity snaps back as far as it can in the meantime, we risk a vicious cycle of business failures and rising unemployment that condemns us to many years of economic struggle even if vaccines, treatments or acquired immunity arrive relatively soon.

So while stockmarkets are justifiably taking the view that a year or two of lost profits has little impact on the long-term fundamental value of companies, they are still implicitly betting that the wider economy rebounds as much as possible. Anything that is not V-shaped at first means greater medium-term risks, not just a slower recovery. Hence watching the short-term economic data is a lot more important now than it would usually be.

Ignore GDP, watch consumers

That doesn’t mean fretting over GDP numbers. First, these don’t arrive in time to be useful. The Office for National Statistics will release its UK GDP estimate for April to June on 12 August – more than one month after the end of the quarter. Second, we already know what it will show – a gigantic recession. The actual magnitude is irrelevant. What matters is what’s going on right now – that means looking at more timely leading economic indicators (see below).

So far, these look modestly encouraging. UK retail sales were nearly back to pre-lockdown levels in June. Restaurant and pub trade seemed to be at around 70% of the pre-Covid-19 level by mid-July, which is a reasonable start given that the government has spent months trying to terrify people into staying in their homes. New car sales were weak in June, but it seems buyers may have held back in the hope of a government incentive scheme. The picture appears broadly similar elsewhere: the OECD composite leading indicators show activity starting to bounce back globally in June. Unemployment remains very high and job vacancies low, but hiring and firing always lags the cycle. In short, uncertainty is high, but if you’re an optimist, a V certainly looks possible.

I wish I knew what economic indicators were, but I’m too embarrassed to ask

An economic indicator is any statistic that allows us to analyse how the economy is performing or is likely to perform in future. Indicators are often used for monitoring the business cycle – ie, the shorter-term shifts in economic growth around its long-term trend caused by periods of boom (in which the economy is expanding) and recession (in which it is contracting). 

A single business cycle is a period of time that includes a boom followed a recession. Identifying the point when the boom is turning to bust should be extremely useful for investors – but this is very difficult to do consistently.

Indicators are classified in three main ways. They may be procyclical (increase or decrease in line with the wider economy), countercyclical (move in the opposite direction to the economy) or acyclical (no consistent relationship with the direction of the economy). Those that are correlated with the economy may be leading, coincident or lagging, depending on whether they usually change before, during or after the business cycle. 

The most important for an investor’s purpose are leading indicators. No leading indicator has a perfect record and the most useful ones vary between countries due to differences in the structure of the economy and to what data is gathered. However, data such as new manufacturing orders, new housing starts, retail sales and car sales are often helpful. A composite leading indicator (CLI), such as those compiled by the OECD, tries to combine several leading indicators into a single index that has more consistent predictive power than any one individual indicator.

Job-related data – such as unemployment and wages – are mostly lagging indicators, despite analysts often citing them as evidence that a boom is still robust. That’s because employers tend not to fire workers until a recession is well under way or hire new ones until the recovery is evident.

Recommended

Will energy prices go down in 2023?
Personal finance

Will energy prices go down in 2023?

The Energy Price Guarantee will now be extended, but how much will your gas and electricity cost you in 2023?
9 Dec 2022
What is an annuity?
Glossary

What is an annuity?

Annuities are growing in popularity as rates increase. But what is an annuity, and how do you get one?
9 Dec 2022
Profit from patience
Advertisement Feature

Profit from patience

Smart investors will reap the rewards by staying focused on the long-term, research from Alliance Trust shows.
9 Dec 2022
National Grid gets ready to pay households to cut energy use this weekend
Personal finance

National Grid gets ready to pay households to cut energy use this weekend

The cold weather and unfavourable wind conditions have raised concerns about electricity supplies, prompting the National Grid to consider paying hous…
9 Dec 2022

Most Popular

Is it cheaper to leave the heating on low all day?
Personal finance

Is it cheaper to leave the heating on low all day?

The weather is getting colder and energy bills are rising, but is it really cheaper to leave the heating on low all day or should you only turn it on …
1 Dec 2022
Radiator vs electric heater – which is cheaper?
Personal finance

Radiator vs electric heater – which is cheaper?

We compare the costs, pros and cons of radiators and electric heaters and see which one will help keep your energy bill as low as possible.
28 Nov 2022
The pros and cons of smart meters – should you switch?
Personal finance

The pros and cons of smart meters – should you switch?

A smart meter can help you keep tabs on your energy usage, but is it better than a regular meter? We take a look at smart meters vs regular meters.
2 Dec 2022