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Have we learnt the lessons from history?

10 September 2021
Trust Registration Service

Jonathan Marriott, Chief Investment Officer

Last week, I highlighted the danger of making assumptions based on history repeating itself or on mathematical models. However, there may still be lessons for governments in how they respond to events. In May last year in the middle of the pandemic, I reviewed past pandemics and looked for ‘Lessons from History’. My conclusion at that time was as follows:

  • Governments and central banks should not raise interest rates.
  • Governments should avoid raising taxes.
  • Governments should not instigate a trade war.
  • Equity investors should avoid getting caught up in fashionable trends and should look at long-term business models, and the valuations that are applied to them.

While progress in fighting the pandemic varies from country to country, the vaccine has given us light at the end of the tunnel and life in some places is gradually returning to normal. Nevertheless, the rise of the Delta variant and rumours of another lockdown later this year remind us that the pandemic is far from over. So far, governments and central banks have pumped money to see us through the crisis. However, in the US, President Biden has been proposing tax rises to pay for infrastructure spending and, in the UK, the Government announced an increase in National Insurance to fund the NHS and social care. Under President Reagan in the US and Mrs. Thatcher in the UK taxes were cut, but economic growth meant that the tax take went up. Small government and low taxes have been the policy of Conservative politicians since then. Boris Johnson, in the face of the pandemic, has ignored this, a brave move for a Conservative.

Central banks meanwhile have cut rates and resorted to buying bonds to boost the economy further. So far this year, economic growth has been stronger than expected. Hence, on both sides of the Atlantic, there is talk of tapering the bond purchase programmes. The Federal Reserve (Fed) is expected to announce the start of tapering before the end of this year. This week, the European Central Bank (ECB) President, Christine Lagarde, said the “Lady isn’t tapering.” However, the ECB has a flexible programme and is slightly reducing the pace of its Pandemic Emergency Purchase Programme. The ECB has continuously raised its economic growth forecasts for this year. The Bank of England has also been talking of reducing its purchase programme but voted 7-1 to hold it at the same level at the last Monetary Policy Committee meeting. 

If growth remains robust, the central banks will be keen to reduce quantitative easing to regain some fire power in the event of another slowdown. However, the Fed has made it clear that they are setting a higher bar for an interest rate rises. While tapering is on the cards, rate rises are some way off. Central banks may have further reasons to be cautious. The Delta variant continues to cause concern in many parts of the world. The quick gains in growth on getting back to work are behind us and there are signs that growth from here on out may be slower. Consumer confidence has been waning and survey data suggests growth is slowing from the heady pace in the first part of the year. 

I have often referred to fiscal and monetary stimulus working hand in hand to fight off the economic impact of the pandemic. As we recover from the pandemic, fiscal tightening (in particular tax rises) may restrict the ability of central banks to tighten monetary conditions. In any event, actual interest rate rises in Europe or the US seem far off. The UK has a more complex picture. Brexit has put additional strains on supply chains, costs of transport and labour. While not a trade war as such, some of the impact of Brexit is similar to one. This may be transient as we develop new trading relations around the world but for now it is likely to add further inflationary pressure in the UK. If there was no pandemic, the economic impact of Brexit would be higher on the news agenda, as deciphering what is a pandemic effect and what is Brexit is rather difficult. For now, the Bank of England remains on hold and the tax rise may mean this remains the case for longer. Ultimately when this occurs, the high proportion of home ownership with mortgages makes the UK particularly sensitive to rate rises and as a result moves will be slow and to a limited extent.

When I look back at the conclusions from my ‘Lessons from History’ report, the lessons were well learnt in terms of the fiscal and monetary stimulus. I worry now that tax rises and tapering are coming too soon. On the positive side, central bankers appear to be well aware of this risk and it seems likely that they will only move very gradually to ease back on the stimulus measures. Post-pandemic supply chain shocks, the deflationary forces of technology, globalisation and demographics may reassert themselves. As such, even when they get round to rate rises, the next peak in rates will be well below the last. In Europe, where the demographic effect is particularly harsh and inflation has been hard to generate, we may not see actual rate rises and only tweaks in purchase programmes.

Finally, the conclusion on equity investment remains as valid as anything. During the pandemic, we have seen high dispersion of returns and big swings in sentiment. As ever, you need to keep your head when others are losing theirs and focus on the long-term business models rather than short-term noise.

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