Over the last week we’ve seen a growing number of articles picking up on what I think could be the two big stories over the next year or so, post corona peak panic – helicopter money and inflation.
The first is centred on the looming debate about what we do when we’ve moved out of peak panic and the recovery starts, sort of….The issue here is that more and more of us worry about 1) a second wave, b)are also becalmed by timidity and genuinely fearful c) combined with genuine concern about what might catalyse positive sentiment. This forces many of us into the W scenario – a tepid first recovery, then another downturn as the virus re-emerges (perhaps from the developing world) which coincides with growing worries about a credit crisis, and then a final rally perhaps Q4 this year or Q1 next year.
As you would expect from a traditional Keynesian, I am most worried about the lack of animal spirits. My sense is that consumers are still terrified and worried and that they won’t see any reason to start spending excessively. If anything, I worry that we’ve scared them so much that they’ll start using any extra spare cash to build up their savings to provide a greater cushion against a future scare.
This leads to the next concern – what on earth can government do next to enthuse consumers? The existing, huge array of measures are really just designed to stabilise a dreadful situation. They are not necessarily designed to encourage people and businesses to invest and spend. Most of the conventional armoury of central bank tools have been used (though not all), so we need new ideas and tools.
Step forward various versions of helicopter money plus maybe medium term universal basic income. Republicans in the US will no doubt mutter about even more ambitious tax cuts but I doubt this will work if much of the money simply goes to the very rich or mega cap corporates who have already buttressed their finances using the corona stabilisation measures.
Which is where helicopter money comes in handy. It gives money directly, and immediately to everyone but mostly to those who need it most (and have the last propensity to save).
But this then raises the next $64 trillion question. What happens if inflation lets rip? Ideally central bankers would like a fair wodge of inflation to scrub away some of that debt mountain. But inflation is a slippery beast and very difficult to control. To give one simple example – commodities. I think we could easily build an argument that we are now seeing gargantuan capacity destruction in bits of the commodity spectrum, not least oil. This extra capacity isn’t coming back (thank god for environmental reasons) which could feed through into big price jumps once the economy is humming (hopefully) in 2021 and 2022.
Controlling a massive money drop and working out how inflation (post money drop) might shoot out of control without the right institutional and policy tools is at the heart of a fascinating debate on Bloomberg last week. Columnist John Authers led a conversation about “The Case for People’s Quantitative Easing” with its author, Frances Coppola, and Bloomberg Opinion’s Clive Crook. You can see a transcript of the debate here – https://www.bloomberg.com/news/articles/2019-10-17/authers-notes-send-in-the-helicopter-money?sref=YsjYbPpy.
Frances’ own excellent blog is at http://www.coppolacomment.com. I highly recommend it even if you violently disagree with her arguments.
I heartily recommend reading all the way through the interview – this debate will frame economic policy for the next decade and impact investor portfolio decision making at a monumental scale. It could, arguably, produce a huge boost for equity valuations but might also presage a new era in which labour pushes down the share of capital in national output.
CAPE and small caps in the UK
Reading through an investment presentation by the excellent team at Montanaro – UK based mid to small cap managers – I stumbled across a fascinating chart mapping out the long term price to earnings ratio for UK small caps. Otherwise known as the CAPE ratio, this is usually used within a US context to look at the cyclically adjusted value of the US market. It’s mostly (though not exclusively) based on the work of economist Robert Shiller and you can find the current US value here – http://www.econ.yale.edu/~shiller/data.htm. As an aside, the multiple is a toppy 26 times earnings. On any basis, this can’t be regarded as cheap!
Anyway, I haven’t see it so widely used for UK equities, and especially UK small caps which is what caught my attention in the Montanaro presentation. My interest piqued, I asked Charles’ team to see if they could update the numbers, which they have below. They reckon that UK small caps were at the beginning of last week at around 18% below average valuations. This is close to outright buy territory but not quite in what I would define as cheap.