21 December 2020

Despite the Christmas gloom, the markets are right to remain positive

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I often think the wider world doesn’t pay enough attention to the signals provided by financial markets. Alas, this isn’t helped by the way in which market moves are often reported.

Monday morning provided some good examples. One of the first headlines I read was “more than £33 billion has been wiped off the FTSE 100 over fears of a no-deal Brexit and new coronavirus restrictions”. To be fair, the numbers were correct. But the narrative was not.

For a start, a swing even of £33 billion is not a big deal. The market capitalisation of the FTSE is close to £2,000 billion. It’s not unusual to see this fall – or rise – by tens of billions every day. What’s more, it would be helpful to put the falls in the UK in the context of what’s happening elsewhere.

A more accurate reading would have been “stock markets fell across Europe, led by airlines, as new coronavirus restrictions hit the travel and hospitality sectors. Shares in London dropped by a similar amount to those elsewhere, despite persistent fears of a no-deal Brexit”.

That puts the emphasis where it belongs – on Covid – not on the UK-EU trade talks. Unless, of course, you believe that the main gainers on Monday – Ocado and Just Eat – are obvious hedges against a no-deal Brexit.

It’s also important to view the stock market moves alongside those in currency markets. The FTSE was cushioned by the fall in the pound, which will increase the overseas earnings of UK-based firms in sterling terms. A weaker currency has economic costs too, but this at least is a reminder of one of the benefits.

The final missing point – and perhaps the most interesting – is that the fall in the FTSE on Monday morning made only a small dent in the rally since November. (The FTSE 100 bottomed out at around 5,500 at the end of October and was still around 850 points above that level at Monday lunchtime.)

This is, if anything, rather reassuring. It is a signal that stock markets still think that the good news on the Covid vaccine is more important than the possibility of new restrictions stretching into the New Year. Needless to say, markets don’t always get it right, and they are driven by more than just the outlook for the real economy. But they are much better at taking a longer view than the average headline-writer.

Indeed, I think they are right now. The renewed tightening of Covid restrictions could still have a devastating impact on the economy, but there are good reasons for optimism.

We can take some comfort from the evidence so far from the lockdowns in November. It looks like the hit to economic activity last month was smaller than many had feared. Business surveys suggest that UK GDP fell by around half as much as the 7% month-on-month decline pencilled in by the OBR.

Consumer and business confidence also seem to have recovered quickly in December. In the meantime, the extension of the Government’s furlough scheme has also helped to protect jobs. Unemployment is still rising, but at a much slower pace than might have been expected, and some were worried it might already be twice as high.

It is worth stressing too that the new restrictions do not (yet) amount to full UK-wide lockdown. The new tiers will still be reviewed every few weeks and there is now light at the end of the tunnel, thanks to the rollout of the vaccine.

Nonetheless, there are still big downside risks. The cumulative effect of successive lockdowns could be much greater. A third lockdown may be the final straw for many businesses – especially in hospitality and travel – which have only just survived the first two. The additional uncertainty caused by another cycle of stop, start and the stop again could also be particularly damaging for confidence and overshadow the good news on the vaccine.

The next few months are therefore going to be extremely challenging for the many businesses and families that are at growing risk of being left behind. But, on balance, the equity markets are probably right that the prospects for the UK economy will look a lot better in the spring.

There are two other positives to take away from recent market moves. First, the yields on UK government bonds have remained extremely low: the cost of borrowing for 10 years in the gilt market is around 0.2%.

Admittedly, this is mainly because expectations for growth, inflation and short-term interest rates are also low. Risk-averse investors are happy to park excess savings in the relatively safe haven of government bonds. But this is also a reminder that, in the current economic conditions, even a huge amount of additional public borrowing is relatively easy to finance.

The second positive to take away is that sterling has been remarkably stable over the last few weeks, despite the impasse in the UK-EU trade talks. This mainly reflects the markets’ confidence that some sort of deal will still be done, or at least that both sides will do as much as they can to minimise any short-term damage if one is not. Once more, I’d put more weight here on the signals from investors with real money on the line than on the latest noise from the media.

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Julian Jessop is an independent economist.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.