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What a difference a vaccine or three makes. Share investors who had shunned companies most damaged by the anti-pandemic policies suddenly raced in last month to buy the sectors and national markets that have lost most this year.
I quickly changed the emphasis in the FT fund, switching out of the US and the Nasdaq technology index which had done so well into a general world index to capture some of the gains in the left-behinds. With the help of this most recent rally, the fund is up more than 10 per cent this year. That compares well with most balanced funds.
Many scarred and squeezed businesses have seen share recoveries long before their business problems are over. The strong performance of such stocks in the face of collapses in profits and dividends has depended much less on the companies’ performance and prospects than on the central banks’ easy money policies.
It leads me to ask “Is there a magic money tree after all?” The way some authorities are behaving, it seems they think there is. This year we have seen a massive expansion of money growth in advanced countries, and huge expansion in state borrowing. The advocates of modern monetary theory claim that so far there have been no adverse effects.
Inflation in goods and services has indeed fallen or remained very low. The extra money and borrowing have prevented a worse recession and seen off a market meltdown and banking crash. Markets stay high and go up in the hope that governments will spend and spend again.
But could this liquidity surge end in trouble? History is littered with countries which tried similar policies in different circumstances and ended up in hyperinflation.
Of course, this time too there has been inflation. But it’s been confined so far to asset prices, including stocks and some types of property.
The huge hole made in incomes and output by tough anti-Covid-19 measures early in 2020, and later with the second wave, has required governments and central banks to print and spend. That has helped fill the economic pit with temporary subsidies and loans at ultra-low interest rates. The stimulus has been crucial to share market rallies. So far so good.
US money supply growth over the past year is up 23 per cent. For the euro, the figure is over 10 per cent, as it is in the UK. Japanese money supply growth is also much higher than last year.
If the central banks were to continue with these elevated rates of growth for too long as we come out of the controls imposed to combat the pandemic, we should expect general inflation to pick up. It is unlikely the normal rules of economics have all been torn up by the virus.
But, current ultra-low rates can continue for longer on the theory that we are witnessing the adoption by other parts of the world of the Japanese model, which has involved sustaining the economy with cheap money for two decades. There is no need to worry unduly yet about the West losing control of inflation.
Japan has taken her state debt up to an eye watering near 250 per cent of gross domestic product (GDP) whilst borrowing money for up to 10 years at zero or negative rates. Inflation has remained extremely low. Japan has bought around half its own state debt through the central bank which has allowed continued public spending and borrowing at no cost.
However, while the US and the UK can copy Tokyo for a while, they cannot do so for as many years as Japan. Tokyo mostly runs a balance of payments surplus, so it does not need to borrow or sell prime assets to buy imports in foreign currencies as the UK and US do.
Japan also has an ageing population with a savings habit, making it easier for the Japanese government to sell its debt to Japanese buyers. So its huge debt is almost entirely a domestic charge with little or no interest to pay, not exposed to the vagaries of international foreign exchange markets.
It seems likely that 2021 will see some recovery from disease-torn 2020. Several vaccines may well be rolled out, and as more people have a vaccine so more controls can be removed from damaged sectors like travel, hospitality and leisure. Some successful companies in these sectors will recover well, but others will go through expensive capital reconstructions or pass into insolvency. Central banks need to keep the stimulus going for long enough to ensure a good recovery, but not too long to trigger an inflation. They should wait until GDP recovery is well set and private credit growing sufficiently before tightening.
None of this will change the two big trends which continue to dominate our lives and markets, the green and digital revolutions.
People may well rejoice at returning from some of their current online activities to face-to-face contact with other people in the same room.
The large increase in market share achieved by digital companies in everything from shopping to entertainment and communications under the lockdown will not rise so quickly from here. But these companies will keep many of their new customers. Working from home, the use of laptops, pads and smartphones, online shopping home entertainment will all play bigger roles in our lives.
The green agenda is accelerating, with the US joining the enthusiasm for green energy policies. Coupled with the new enthusiasm for investment that follows environmental, social and governance (ESG) rules, these changes will increase the intense competition to buy the shares of the winners from these revolutions.
The digital and green themes remain well represented in the portfolio’s index funds. Many of these shares are expensive, but there will be intense competition to keep buying them as environmentally-aware investing grows apace. As long as central banks supply liquidity, investors will pay up for growth.
Sir John Redwood is chief global strategist for Charles Stanley. The FT Fund is a dummy portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global stock markets while keeping down the costs of investing. firstname.lastname@example.org
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