Lockdown Day saw the market hit rock bottom – could Freedom Day mark a top?
When the UK locked down against Covid, markets plunged, but recovered quickly. Could England’s removal of restrictions mark the market top, asks John Stepek, or is there further to go?
Just before I get started this morning, make sure you listen to our latest podcast with economic historian and author Russell Napier.
It’s a potted history of how we got to where we are now (financially speaking) and why the only really politically palatable option is to inflate our way out. It sounds complicated but Russell has a gift for explaining these things in comprehensible plain English – don’t miss it.
Back to today. It’s Freedom Day in the UK! And nature, with its impeccable sense of humour, has of course arranged things so that the prime minister has to spend the day self-isolating.
It’s almost as though “buy the rumour, sell the news” doesn’t just apply to markets.
Markets are pricing in another period of fear of a weak recovery
The somewhat fizzling feel to “Freedom Day” is unsurprising.
On the one hand, a lot of the most restrictive restrictions have already been lifted, or are at least being largely ignored. On the other hand, there are still plenty of things that we can’t really do (or at least not without incurring massive hassle and uncertainty).
And the fact that it’s coincided with the start of the summer holidays (or the middle, if you’re in Scotland) means that lots of us won’t much notice the difference (except that the kids won’t be working remotely at the kitchen table).
This sense of fizzling is also being reflected in markets. The FTSE 100 is down this morning; US markets had a rough week last week; reflation trades are not doing well.
Part of this is purely the market’s discounting mechanism, as encapsulated in the old trading saying, “buy the rumour, sell the news”. Put simply, markets price in stuff before it happens. The coronavirus pandemic itself has provided some of the most vivid examples of this in action.
Markets hit rock bottom virtually on the day that lockdown was announced in the UK in late March. Why? Because central bank and government action put a floor under the market by making it clear that the worst-case scenario – a pandemic plus mass bankruptcies and another financial crisis – would not be allowed to happen.
Once mass bankruptcies were ruled out, it was a pretty logical next step to start buying markets again, particularly as more and more evidence rolled in from China that the pandemic could be ridden out, given time.
We then saw markets wilt somewhat during the late summer and early autumn as it became apparent that Covid-19 was mutating and that it wouldn’t just go away and that our hopes for getting free last August were largely false ones.
But then in November, we got news that the vaccine – which many people had said was at least five years away – was just around the corner. Markets took off again.
Now, we’re back at the point where not only are variants starting to threaten the end of lockdowns again, but central banks are starting to talk a little bit tougher on monetary policy.
It’s no wonder that sentiment is shifting to the downside again. We’ve gone from pricing in rampant reflation to fearing that the recovery won’t be quite as vigorous, that it’ll be far more drawn out, and that this time, the government and central banks won’t backstop it in quite the same way.
Of course, markets are also contrary things. They bottomed out on Lockdown Day. It would be entirely in character for them to top out on “Freedom Day”.
Four reasons to believe that the recovery will continue in the longer run
So what’s next? If you’re a short-term trader then the answer is: I have no idea, and chances are neither do you.
But if you’re a long-term investor, what should you be considering?
Firstly, we do have vaccines. And they do work pretty well, so we’re in a better place than we were when this first broke out.
Secondly, there are still vast sums of money floating around in the system. More importantly, there are signs that workers are asking for, and getting, better pay and/or conditions.
There was a good piece in the Wall Street Journal the other day. It pointed out that lots of workers in the US, who had been working in hospitality for years, have been forced by the pandemic to investigate other areas of employment.
Much to their pleasant surprise, they’ve found that they can find easier jobs and get paid more money, and they have no intention of going back to hospitality.
It’s funny: we accept that people are apathetic about changing something as basically irrelevant as a current account. But when it comes to the labour market, where switching costs are far higher and friction much greater, we don’t really factor it in.
One simple driver of greater wage growth might just be that employees gain a better understanding of their actual value (as has happened post-pandemics in the past).
Thirdly – and I think this effect has thus far been underestimated – there’s the “wealth” effect from housing. This is something we haven’t seen for a while. But it’s one reason to stay optimistic (for now) on the consumption boom.
Consumers in both Britain and America are starting to use their homes as cash machines again. In other words, they’ve seen the value of their home go up, so they remortgage and borrow more against the house.
Sometimes this is spent on “investing” in the property – so putting in a loft extension, for example. And sometimes it’s spent purely on consumption – for example, a dream holiday. But either way, it’s spent, and that then boosts economic activity.
I’m not saying this is necessarily a good thing – booming house prices are a big part of our general political and social malaise, and we all know where leveraging up households and the property market got us last time.
But it is a reason to believe that the recovery will have legs.
Finally – and this comes back to the same logic we’ve been outlining for about a decade now – if things go pear-shaped, what do you think central banks and governments will do? They might be all “taper” talk now, but if we get a drop of 10% on the S&P 500, or governments start re-imposing strict lockdowns (as in Australia), it’s hard to see any sort of tightening rhetoric surviving.
In short, either we get a decent recovery, or we get governments and central banks pumping more money into the system. So stick with your long-term plan, make sure you have a watchlist for the more panicky moments along the way (so you can pick up stocks you like, on the cheap), and otherwise try not to get too stressed out.
Executive editor, MoneyWeek