One of the wisest things ever said was Charlie Munger’s advice to know “the edge of your own competency.” It is, he said, “not a competency if you don’t know the edge of it.” I fear that forecasters trying to predict the size and duration of the post-lockdown recovery in demand are ignoring this advice, because the truth is that we just don’t know.
Of course, the lockdown has forced many of us to save, and we can roughly estimate the scale of this. The Bank of England reports that households’ bank deposits rose by 12.3 per cent in the year to March. If we assume that in the absence of the pandemic they’d have grown at their average rate for the past 20 years, this means people have £100bn of excess cash. That’s equivalent to over 8 per cent of last’s year’s total consumer spending.
Just because people have money, however, does not mean they will actually spend it all. Before the pandemic companies had for years had huge cash piles. And for years, their investment fell short of forecasters’ predictions. The same could happen to consumer spending.
One uncertainty here is the extent to which our habits have permanently changed or not. Will we carry on eating and drinking in each other’s gardens rather than go to pubs or restaurants? Will we go back to walking round malls and high streets and so be tempted to make impulse purchases or will we instead continue to stay home and shop online?
Another uncertainty is the extent to which people actually welcome the sense of financial security they get from having more cash and less debt: consumer debt has fallen by 8.6 per cent in the last 12 months. If they do then they’ll not spend so much of the excess cash. To put this another way, how rational are our spending decisions. If our pre-pandemic spending was driven in part by a lack of impulse control or by peer effects, the pandemic might have kicked us into a welcome frugality. If on the other hand, our spending was rational then we will return to it.
Macroeconomic forecasts traditionally work on the assumption that past relationships between economic events will continue into the near future. But we cannot yet know how much the pandemic has permanently disrupted those relationships.
Nor do we know the impact or not upon inflation of whatever extra spending we get. We know there’s still lots of excess labour: 1.7 million officially unemployed, plus a million working part-time who want a full-time job, plus 1.9 million out of the labour force who want a job. But inflation can arise not merely from a lack of aggregate supply but rather from mismatches between the patterns of demand and supply. And nobody knows how great these will be.
But suppose we did know. Suppose we knew the course of GDP, inflation and short-term interest rates over the next couple of years. It’s not obvious how this would help us as equity investors. Would shares take joy from stronger growth or fear rising rates whether or not they had yet materialized? Going from even a good macroeconomic forecast to an asset allocation, let alone a stock selection, requires a lot of steps.
My advice, then, is not to trust macroeconomic forecasters however confident they seem. Instead, we must ensure that our portfolios are resilient to whatever surprises the world is bound to throw at us.
