What to invest in as we move into a world beyond lockdown

Has Covid-19 changed our relationship with cities for good? Will government responses to the pandemic finally ignite inflation this year? John Stepek questions the experts at our (virtual) Christmas roundtable

Roundtable participants

John Stepek: This time last year, the UK election was over, Brexit was near an end, things were looking up. Then we spent most of 2020 in lockdown. Yet, if you were to look at the market now for the first time, you would never realise that Covid-19 had happened.

Max King: Yes, I thought you’d make 5%-10% from a decent portfolio, but we’re at the top end of that range. The surprise is how well private businesses have coped, including delivering vaccines on target. 

Lucy Macdonald: The market reaction isn’t so surprising when you consider the huge liquidity boost, which did what it always does – produced a big bounce back. The big question, which we also raised last year, is whether there will be inflation as a result.

Jim Mellon: I was actually amazed at how primitive the world’s response to the pandemic was. I don’t think it was any better than in 1920, except that vaccines have been discovered and are being rolled out. Even then, they’re probably on the late side because going by Farr’s law of epidemics, we’re close to the point of dissipation. So I was very surprised by the very quick rebound from the March lows. One has to ask now whether there is any value in the markets at all, or whether one should be very cautious.

But in response to Lucy’s point, I do think inflation’s coming. Perhaps not immediately – you don’t get this sort of economic shock without deflationary consequences. But equally, you can’t have this degree of monetary and fiscal stimulus, and then a recovering economy with people going back to work and demanding more pay, without inflation. Gold’s taken a bit of a breather, as has silver, but I think they’re both poised for a massive run next year.

Dominic Frisby: The key is wages. And in the real world, there’s a lot of competition for not a lot of work, particularly if you look at restaurants, bars, theatres, comedy clubs and the like.

Max: Yes, labour costs may be kept down, which might be very good for corporate profit margins.

John: Well, there’s a lot of pent-up demand from extra savings. But the high streets are also full of empty shops that aren’t coming back and lots of people have lost their jobs. How will that play out?

Steve Russell: When you look at the government debt position, inflation is inevitable – there is no other way out. But that doesn’t say anything about what happens next year. To your point about the high street, you’re seeing a pattern where there is a deflationary demand shock to some parts of the economy and an inflationary supply shock to others. What intrigues me is the inability of capital and labour to shift from one to the other. You just can’t get that money out of high-street shops into online delivery at the pace you might want to, for example.

Max: This is nothing new – the economy is always transitioning from old to new.

Steve: Yes, but that’s not the point. The point is that everybody focuses on the deflationary half and not on the inability to meet demand elsewhere. So I’m not disagreeing that we will transition. But it’s not instant. The best example I’ve got is from the “old economy” bit. Before the second lockdown, I went to the pub a couple of times. I live in southwest London, so not full-on London, but London prices. A pint of lager was £6.15. Before Covid-19, it was £5; outside of London it was £3.50. But I happily paid up, because that was the cost of providing it – the pub had to have waiter service and couldn’t admit as many customers. And yet that’s just the same item now priced, what – 25% higher? Those are the sorts of impacts that could come through quicker than people expect.

In any case, the key point on inflation is that markets are not pricing in any risk of it at all. That’s where we see a massive threat to the vast amount of money in bonds or growth equities. That will sound the death knell for the FANGs [the big tech companies such as Facebook and Google], for example. It won’t necessarily be “oh no, there’s high inflation” – it’ll be “oh no, there’s a risk of it and I’ve got to do something about it”. That’s what will jolt markets.

There’s still plenty of room for recovery

John: So do you think this bounce in value versus growth has legs?

Lucy: The two are intimately related. If a recovery leads to bond yields rising, that could tip things over. The question is: will bond yields be capped, so that you get inflation, but you don’t get yields rising? If so, then growth can probably go a bit further. But the other big risk to the FANGs is regulation. The Department of Justice is already looking to fine Google, and the Federal Trade Commission is talking about breaking up Facebook.

Jim: Yes, over the last ten years the banks have been the cash cows for governments in terms of fines and regulatory penalties. Now the FANGs are surely the number-one target, starting with Facebook. It’s got billions in cash on the balance sheet – why wouldn’t you take half of that away, then do the same to Google and the others as well? That’s got to be a strategy that debt-laden governments are considering.

Max: On the “value” rotation, I’m a bit of a sceptic. Yes, there have been lots of recovery trades, but the old deadbeat value stocks – oil, banks – will probably remain that way. They might bounce, but I can’t see a case for investing long term. Some growth companies – the tech stocks, say – may need to take a breather for the fundamentals to catch up with their share prices. But I don’t see this as a great renaissance for “value”.

Steve: In the end, value is a mixture of price and growth – if you get both right you get good value. It’s not buying stocks that are in terminal decline. There’s a whole load of stocks that can go up another 40%-50% from here and a “panic rotation” could accelerate that. I think UK banks are stupidly cheap and could easily double – but that doesn’t necessarily mean they’ll compound at 15% per annum beyond that.

John: Are you negative on their long-run prospects?

Steve: That’s slightly misreading it. But for the banks to do more than just recover – getting back to 80p for Lloyds would be a start – we need to see the yield-curve steepening. I don’t see that happening for a long time. While we are definitely in the inflation camp, we are also definitely in the “yield curve control” (see page 21) camp. So banks might return to fashion because they can pay out a dividend of 6% and grow at nominal GDP (which could easily be 5%-6% if you’ve got 4%-5% inflation and 1% real growth). That’s a nice return. But I don’t see them becoming growth stocks until you get actual change in monetary policy.

Lucy: So you think bond yields will be capped?

Steve: I see no other option. If bond yields aren’t capped, the amount of tax revenue needed to pay the interest on the outstanding debt goes through the roof. You can’t possibly raise enough tax to pay it, let alone pay some wages as well.

Lucy: But do you not think that would support the growth end of the market and long duration assets?

Steve: No. My fundamental view (which the market may not agree with until far later than I want it to!) is that the rate investors use to discount future cash flows has to be the inflation rate, not the prevailing interest rate. Now, for almost all of history these have been roughly the same thing, so we use the interest rate as a discount rate. However, if you’ve got inflation of, say, 5%, but interest rates are nailed to the floor at 0%, then I believe that the discount rate on the market has to go to 5%, not 0%. That’s what will kill the FANGs, for example. But markets may not get that right away. They might say: “Yippee! The Federal Reserve’s going to use yield-curve control! Those stocks are great again. We can justify paying infinite price/earnings (p/e) multiples because the discount rate is 0%!” But eventually I think that will change.

Return of the commodities super-cycle?

John: On inflationary pressure – Goldman Sachs has talked about a commodity super-cycle kicking off again. And copper has just gone up like a rocket since 23 March – surely that’s got to be saying something?

Dominic: I don’t know about a super-cycle, but I’m interested in a few commodities right now. Tin is an interesting niche play and platinum too – if hydrogen vehicles, which use platinum in their fuel cells, take off, that’s got to be bullish for platinum. But the one I’m really bullish on is oil.

Jim: I think both oil and tobacco are on the way out over the next 20 years. They’re going to be self-liquidating trust-type businesses. But oil is a great idea – I would definitely buy the global oil majors, because they’ll produce excellent dividends as they liquidate.

Max: There’s a lot to be said for a short-term commodity bounce. But never forget that the world is very good at responding to higher commodity prices by using them more efficiently. So what goes up comes down even faster. I look forward to the day – I hope it’s in my lifetime – when not a single barrel of oil passes through the Strait of Hormuz, because nobody wants it. The future of oil is what the future of coal was in the past.

Dominic: Nearly 70% of electricity still comes from burning fossil fuels. There’s still huge demand for coal.

Max: But look at the UK – 45% of our electricity comes from renewables now. Yet eight years ago the government set what seemed to be a ludicrous target of getting to 30% by 2020. These things are happening much faster than anyone realised.

Dominic: I’ll bet you Max that we’ll see $100 oil before the end of 2022.

Max: Yes, but the dollar might be the American peso by then, so $100 won’t mean very much!

John: Jim, your new book, Moo’s Law, looks at the “clean meat” industry. Talk us through that.

Jim: I think clean meat’s going to be very big. Plant-based meats have shown the way – we are all familiar with Beyond Meat and Impossible Foods, for example. But within two or three years’ time we’re going to see the first food coming out of labs at mass scale, hence the title of my book – Moo’s Law, [after “Moore’s Law”, a term coined in the tech industry to describe how microchip capacity grew rapidly even as prices fell]. It’s a massive prize. The global meat market is the size of the Spanish economy. Some reputable organisations suggest that within ten years 50% of all meat consumption will be either plant-based or produced in laboratories. Yet most people are not even aware of the industry.

There are about 30 investable companies in the world, moving at very rapid pace, so I wrote a book with my thoughts on which would be the best to invest in. It’s not just about meat: it’s about seafood, leather, cotton – all sorts of materials that can be grown in labs much more efficiently, cheaply and in a more environmentally friendly way than having the cows on feedlots or the chickens in cages. It’s a great way to free up resources. You can release vast amounts of land and water – it takes something like 15,000 litres of water to produce one kilogram of beef. And the biggest contributor to environmental emissions – about 20% – is not transport, it’s animal husbandry. In my view, you’ll be able to grow the best cow’s meat without antibiotics, hormones, or any waste, in ten years’ time and for about half the price of producing cows today. It’s also good for our health.

John: That’s incredible. Speaking of incredible, let’s turn to UK house prices. Despite everything, lots of people are moving and prices have risen more rapidly this year than in about five or six years.

Dominic: It’s as though lower taxes boost activity!

Max: Saville’s was very good on how the pandemic would affect the housing market very early on: everything it said has turned out right. More working from home means people moving further out of cities and looking for larger houses in better locations, with gardens and spare rooms.

Steve: Yes, one impact of Covid-19 has been to realign people’s spending from being focused around their office work day to investing in their homes. And with actual interest rates set to stay low and real (after-inflation) rates set to get more negative, I don’t see a looming disaster for the housing market. Whether in ten years’ time the average house price will be higher in real terms than it is today, I’m not so sure about that.

Lucy: Yes, affordability relative to salaries is still ridiculous. The supply and demand picture should improve because there seems to be a little building boom going on, but it’s interest rates that really make the difference and they won’t change anytime soon.

John: Do you think Covid-19 has permanently changed our relationship with cities?

Steve: It depends on the generation. People in their 20s and 30s who have been working from home cannot wait to get back, because they’re either in a very small flat or in their parents’ home. The attraction of a big city and everything that goes with it is utterly undiminished for them.

Dominic: They haven’t got any money though.

Steve: That’s true. Rents could come down, so underlying house prices won’t be supported as much.

Dominic: A big factor is how quickly you think driverless cars will become a reality. That would speed up commuting and lessen the need to be in a city centre. But if you think we’re still many, many years away from that, then city centres remain attractive.

Lucy: But what you do have now is much better broadband. That makes a huge difference. It really does open up what people can do remotely.

John: And if you only have to go into the office two or three days a week rather than five, then commuting is much less of a restriction on where you can live.

Dominic: That’s what they found in Germany – once everyone went back to work, office occupancy was about 50% lower than before Covid-19.

Max: Well, research also suggests a majority prefer working from home and that it makes them more productive. So net net, an increase in working from home should boost productivity, which might well help the economic recovery, efficiency and profitability.

John: OK let’s move onto tips. Steve, what are you investing in now?

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