15th February 2021
No UK double dip, but much talk of bubbles
‘Worst recession in 300 years’ was how UK media framed Friday’s release of UK GDP growth data for the last quarter of 2020. They were also quick to point out that the -9.9% full-year number was far worse than any other major industrialised nation around the world. What they only reported far further down in their articles was that compared to Q3, the economy had grown +1% in the last quarter of 2020, meaningfully above economists’ expectations of +0.5%. Some had expected contraction and a ‘double-dip’ recession of two consecutive quarters of negative growth (since this current quarter will see a contraction of around -2.5% because of lockdown). That’s no longer on the cards as Q2 is highly likely to rebound sharply (current estimates are for +5%).
Global growth surprise
With vaccines being rolled out across the world, and substantial monetary and fiscal support for the foreseeable future, economic activity in the second half of this year is all but certain to be stronger than 2020. But much of this optimism has already been priced in. Just as last year saw the worst global recession on record paired with booming stock markets, the recovery this year might only match markets’ lofty expectations.
For upside in equities to be supported from here, the economy and global corporate earnings will have to be at least as good as was expected at the beginning of the year. It is welcome news, then, that global growth estimates have been trending upwards.
Looking for the bright side in markets
Even though economic prospects appear positive, for capital markets, it’s always a bit more complicated. For investors, the main anxiety is that the economic positivity, based on vaccination hopes and fiscal support, is putting equities in a more precarious position. No one can deny that, on current price-to-earnings ratios, stocks look expensive relative to history. This is not much of a surprise – after all, it is what you would expect when you combine the deepest global recession on record with a year-long market rally.
Current equity prices are based on the eagerly anticipated future, rather than the impaired present. But the risk of being wrong is still quite high and, at the moment, the payout for that risk (the risk premium ~ the average amount of expected corporate earnings relative to the share price) is low. Goldman Sachs research notes that global investor sentiment is in a ‘risk-on’ phase, with a great deal of cash having already flowed into stock markets.