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Ideas Farm: Betting on a bounce

History suggests the post-pandemic recovery could be very quick
Ideas Farm: Betting on a bounce
  • ECB research points to the potential for a strong recovery
  • Santa may be around for long enough to let the economy deal with Scrooge
  • Loads of ideas generating data

How will the Santa-to-Scrooge pledges by the UK chancellor, Rishi Sunak, play out for investors in UK stocks? A lot comes down to the nature of the recovery we experience. 

The recovery that is most recent in our memories may not be a great template. That recovery was weak and the government’s choice to opt for fiscal austerity is likely to have contributed to the sluggish growth of the economy and thereby the tax take.

But research from the European Central Bank (ECB) on the “scarring effects of past crises on the global economy” suggests we may have less to fear this time around based on the chancellor’s pledges to tighten the fiscal screws come 2023. That is because historically economic recoveries from pandemics have been quick. 

Taking data from 117 countries from 1970 to 2017, the ECB study found that the impact of epidemics on the level of potential output is relatively short-lived, tending to dissipate two years after the end of the epidemic. This is very different to the “scarring” from a financial crisis, which has historically tended to be extremely drawn out.

The global scale of the current crisis is off the charts compared with similar events in the ECB’s sample period, though. To try to account for this, the ECB also tested economic recoveries after wars and the 1973-74 OPEC oil embargo. With these economic shocks, the scars were once again found to heal quickly – although the range of outcomes following wars was wide.

Nothing is guaranteed, but the study suggests there is less to fear from promised austerity in 2023 than there was from the policy when it was adopted following the credit crunch. Adding to the reasons for optimism is the fact that the massive economic shock experienced by the UK has been accompanied by massive stimulus and massive changes to behaviours – working from home, online shopping etc – that could improve productivity. Indeed, stimulus measures mean both UK consumers and UK businesses are sitting on substantial amounts of lockdown savings that could be deployed once the country opens up again.

The fact 10-year bond yields have been rising is probably the clearest indication the market is also gearing up for a strong recovery. The speed and sharpness of this movement in yields also provides a reminder that the UK Treasury needs to play to the crowd and show it is serious about economic prudence, even if it ultimately doesn’t follow through with promises of fiscal restraint. 

We can also see some signs of optimism about the recovery in our Ideas Farm data tables. While the main event over recent weeks has been the dramatic falls being experienced by many growth stocks, our 52-week highs table includes a number of UK smaller companies investment trusts. The kind of shares these trusts hold should be particular beneficiaries of a strong domestic recovery. 

It is also of note that a number of these funds, such as Fidelity Special Values (FSV) and Aberforth Smaller Companies (ASL), adopt a 'value' investment style, owning the kind of battered stocks that appeal to value investors that also have most to gain from a strong economic resurgence.

This week's list of fund managers’ best ideas also picks up the UK smaller companies theme. The table provides the top five holdings of some of the country’s best fund management talent running money in this space.