Chancellor Rishi Sunak’s dramatic loosening of the UK’s purse strings is likely to find favour with voters, who suddenly find themselves with a little more cash in their pockets. At the same time, high street banks were already cutting mortgage rates in response to the Bank of England’s half point cut. But how is this new ultra-loose environment likely to be felt in financial markets?
In the short-term, not much. Global financial markets continued to slide. M&G investment director, equities, Ritu Vohora (pictured) says that while investors are scared and consumers are scared, it may be too much to expect for markets to recover their poise, even with central banks and governments willing to write cheques to support the economy.
“When you look at the different indices, it is very clear this is panic,” she says. “We’ve seen an indiscriminate sell-off across all regions.”
When normality returns to stock markets
However, what about life beyond the coronavirus? It is noteworthy that the Chinese market has been relatively stable in recent weeks as life has returned to some normality in the country. The Shanghai Composite saw dramatic falls in January, but has since recovered its equilibrium and is now sitting at pre-December levels. When normality returns to stock markets, there will be winners and losers from an environment where even looser monetary policy and fiscal stimulus are the norm.
Vohora says the group’s fund managers are using the dip to top up on certain areas that not only look cheap, but may benefit from this new economic climate.
“Emerging markets look much more attractive relative to developed markets,” she says. “We see better valuations, plus a more dovish fed and a weaker dollar. If China contains the virus, that is also good for emerging markets.” She also suggests dividend stocks could stage a resurgence, given a world of low bond yields and interest rates. There are now more companies with high dividends yields backed by reliable cash flow.
The UK is also worthy of a second look. M&G research shows that it is now at 45-year valuation lows and trading at 40% discount to the global index. However, Dan Whitestone, manager of the Blackrock Throgmorton trust, says that investors need to be selective and there are risks in some larger companies.
“We see many larger companies that are hostage to paying dividends they can’t afford. They are starving the business of investment rather than cutting the dividend. We expect to see more high profile dividend cuts this year.” He says any company with a lot of debt is also in trouble, but he believes certain smaller companies in niche areas should be well-supported by the fiscal measures.
A recipe for inflation?
Looking longer-term, there is another consideration. Should the virus outbreak prove temporary – as the experience in China and South Korea suggests – interest rates are at all-time lows and governments around the world have just unleashed major stimulus packages. There is also the oil price. It is already low and the International Energy Agency has said it expects demand to fall in response China’s economic slowdown and the disruption to travel around the world caused by the coronavirus. Lower oil prices tend to fuel stronger economic growth.
In normal times, this should be a recipe for inflation. Many of the stimulus measures announced in the budget and in other countries around the world go directly into the economy, rather than going via the less predictable transmission mechanism of the banks (as had been the case for quantitative easing). There is a risk that people emerge from their self-isolation with cash in their pockets ready to spend again. Inflation has been benign for some time, but can it stay low in the face of this vast caffeine hit?
Any tick up in inflation would be a major shift in the economic conditions that have prevailed over the last decade. In this case, buying bonds in response to the current market crisis would be a dangerous course of action. The equity risk premium over bonds has already widened considerably in response to the crisis, leaving equities looking cheap and bonds looking expensive.
It would also change the type of equities that would look attractive. It could see unloved cyclicals come back into fashion, or smaller companies. It is probably too early to contemplate just yet, but it may be that inflation is the ultimate consequence of this crisis.
