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April was dominated by
coronavirus, as the entire country went into lockdown and the UK
economy came to a standstill. There has been a terrible death toll,
both in hospitals and now emerging also in care homes and people’s
own homes. Worryingly, we are not yet at the end, only at the
beginning of the end at best, and that is before one considers
other future risks such as second waves and the timeline and
success of any vaccine.
Alongside this, there has
been significant economic fallout. Scheduled flights for the UK are
down 93% year on year. Public transit usage is down almost 80%. The
UK has seen early business indicators tumble, notably the IHS
Markit/CIPS UK PMI indices, which showed the steepest contraction
in business activity since records began, and at a pace far greater
than in the last financial crisis. The implication is that GDP will
decline by up to 5% on an annualised basis in Q1 and even more in
Q2. In other words, we are now in recession territory.
Equity and bond markets
fell dramatically but have also rallied since, making back some of
their losses. However, this reflects the significant stimulus from
government and the Bank of England to cushion the effects of the
above, and not the underlying real economic impact. Over half of
all businesses by early April were reporting turnover lower than
their normal range, according to the Office for National
Statistics. 40% reported cutting jobs and over 28% said they were
reducing working hours. This has likely worsened over April, with
many businesses at a standstill. Despite government support, more
than 1.8 million claims were filed for universal credit since the
start of March. As these take several weeks to process, these have
not shown up in unemployment numbers or those seeking out of work
benefits as yet. When they do, it is entirely feasible that we are
looking at a return to numbers last seen in the early 1990s, a
period that still haunts part of the UK.
A shock like this does not
imply a rapid recovery, but rather one that may take us well into
next year and perhaps longer. What does that mean for returns and
portfolios?
Consumer price inflation
dropped to 1.5% in March, driven by sharp falls in petrol prices
and clothing sales. The real rate (the yield once adjusted for
inflation) has marginally improved, but is still strongly negative
at -1.4%. The outlook also is poor with the implied forward real
curve predicting a fall to below -2.5% over the next five years.
The base rate is anchored to 0.1% and may even go negative if the
UK adopts European tactics. That means any improvement would flow
only from rapidly falling inflation, which here implies more pain
for the economy.
For treasury portfolios,
this is a bleak picture for the immediate future. The above shows a
significant drag on returns, negative in real terms for typical
portfolios, and the weakness in the economy increases the risk of
credit downgrades and defaults. Relying on ratings alone with not
be sufficient, and treasuries should look to conduct external
independent reviews to identify gaps, where risks may lie and
understand their resilience to future shocks.
Alongside, income
generation will be more important than ever as councils face more
pressure on services and lose valuable income streams such as
planning and leisure facilities in the current lockdown. But
resilience and risks will also need to be carefully ascertained,
managed and monitored going forward. Here, commercial property
shows increasing risk from our latest weekly Covid analysis
(available on request to CIPFA local authority members at no cost),
though pockets of opportunity remain. Renewables and SME lending
also offer potential opportunities for those willing to undertake
the due diligence.
Looking ahead, the April
data will give us a better sense of the depth of the shock. Numbers
are likely to worsen, but there may also be more clarity on the way
forward when we next reconvene and we can begin to consider the
longer picture with more confidence.
Dr Bob Swarup
Camdor Global Advisors
swarup@camdorglobaladvisors.com
Camdor Global Advisors is a
specialist investment and risk advisory firm focused on providing
insightful analysis, prudent advice and pragmatic solutions for
today’s complex environment to its local authority clients. For
more information, please click here .
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