5th February 2021

There is much which is positive and encouraging.

Last year was difficult, extreme, and tragic, in so many different ways. Yet, as observed in our recent monthly commentaries, there is growing investment confidence in the UK, albeit from very low levels.

The emerging vaccines are vital to restore confidence within markets and wider economies. In the UK in particular, the march of the vaccines, combined with the end of Brexit uncertainty, are a powerful antidote for the UK stock market, which has been under the weather since 2016, since when global investors have kept their distance. The result is that the UK stock market has never been cheaper since 1973 versus the rest of the world.

Some of the gloomiest reports on the UK economy have been factually incorrect, and unnecessarily gloomy, unless their sole purpose is to generate a catchy headline

The contraction in the size of the UK economy (measured by GDP or gross domestic product) has been significantly overstated by the unique way in which GDP is calculated in the UK. No other country adopts this approach. If an adjustment were made for this, UK GDP would have contracted by around 7% in 2020, a similar level to the likes of Spain, Italy and France.

Particularly interesting, total hours worked are back to pre-virus levels. Similarly, the value of UK retail sales only fell by 0.7% in 2020. If you exclude fuel sales (which were down 26%) retail sales were up 2.3%, with the growth in online retailing (+33%) more than offsetting the fall from stores.

What else do we know?

We know that much higher government spending (fiscal policy), continuing low interest rates (monetary policy), resilient employment levels, high levels of savings, and pent-up demand will all be very supportive for the UK stock market as we progress through 2021 and beyond.

On government spending in particular, the pandemic has shown that huge sums can be made available when the need arises. Anyone for rebuilding the world? Perhaps start with our Victorian sewers?

Looking further afield, emerging markets are extremely cheap, and China has momentum. Asia generally had a “good” pandemic, and this is evident in their stock markets, which have not needed the snake oil of zero interest rates, combined with mountainous debt and an investment mania (more below). These three areas present opportunities for investors for years to come.

There are certain types of funds which should do particularly well in the anticipated environment – an environment when governments spend money to rebuild the economy rather than to shore-up the financial infrastructure. Funds such as Schroder Recovery, JOHCM UK Equity Income, and M&G Global Emerging Markets are already outperforming since “Pfizer Monday”, 9th November. UK smaller companies have jumped, and, among a number of outstanding funds, Liontrust UK Smaller Companies remains a favourite. In China, Matthews Chinese Smaller Companies has great long term potential.

All of this gives cause for cautious optimism. Why still the caution?

Successful investing has always involved having two competing points of view. You must always have a sense of the downside as well as the opportunity. The problem today is that those competing points of view are extreme – which is quite challenging!

Since this time last year, the extreme risks, centred on the US stock market, are not simply unchanged – they are greater. Valuations are even more extreme, investor behaviour reached new manic highs, and the debt mountain has exploded upwards. The vulnerability of this wobbly edifice to another shock has grown. And where the US goes, we all go – at least over shorter periods.

It is the US investment mania which is our greatest concern – it is both very visible, if you read the financial press regularly, and also the most reliable indicator of a mania which is now comparable with the biggest in history, such as 1929 and 1999. There is no historical precedent for this ending well.

Unfortunately, just observing the fact of a mania does not help us with timing. This unnatural behaviour has no natural end.

Most recently, some of you would have heard of the mania in the context of Reddit and GameStop, whose shares quintupled a couple of days ago, with a “ferocious and co-ordinated” attack by an army of small investors against hedge funds who had been betting on certain share prices going down.

This is another scary leg to the investment mania in the US which has been in place for the last year, and these ALWAYS end badly. In 2020 we highlighted the extreme and tragic consequences for some – one young man who committed suicide, another in his 60s who lost his whole pension fund in days.

So we are left with the persisting investor dilemma. Balancing US vulnerability to another shock on the one hand, with the opportunities, where the UK stands out, on the other hand.

Optimistically, if confidence continues to build as the vaccines are rolled out, the value in the UK stock market can be unlocked, and the window for that occurring might be a honeymoon period for new President Joe Biden. But we must also keep our guard up.

Since Pfizer Monday (9th November) many clients are lowering their cash levels to nearer 20% of their portfolio, in that spirit of cautious optimism. But do keep your defences up too.

Do talk to your usual adviser if you want to take notably more, or less, risk than is implied by the latter. There is no perfect investment solution – there is only what suits you best.