Monday Digest

Posted 2 February 2021

Outlook: the EU displays frayed nerves and flared tempers

In the middle stages of the pandemic, when things had the potential for going very, very badly, there was a sense of global solidarity and unity among people and politicians. In Europe, although Brexit rumbled in the background, the invisible enemy created allegiances and a concerted defence effort. But allies have returned to bickering now the enemy seems to be in retreat. Perhaps this was inevitable, perhaps it is a sign of a return to normality.

The UK Government is enjoying being the clear leader among European vaccination campaigns, given it was its first big effort organised outside the European Union (EU). The possibility that the UK has a surfeit of vaccines may also give Boris Johnson some bargaining chips for some of the trading issues that were not adequately addressed in last year’s rushed trade deal. Although if that is the plan, then time is of the essence, given there are reliable sources that project that come March there will be a widespread surplus of vaccine vials as production is ramping up rapidly.

Meanwhile, the fault-lines of the EU are yet again exposed. The collective coronavirus vaccine procurement process fell to a small, under-resourced team led by someone with no direct experience. In contrast, the UK put its procurement process into the hands of experienced pharmaceutical professionals and generously prefunded the retooling of production facilities for unproven vaccines – all at tax-payers’ risk. This all led to the President of the European Commission abandoning its plans to trigger Article 16 and impose emergency border controls on vaccines entering Northern Ireland via the EU, amid fears it would not be able to deploy enough vaccines to EU citizens. The embarrassing u-turn that followed, capped a difficult week for Europe, the European Commission’s ability as an executive body is back under scrutiny. Still, holders of European equities and currency should probably not get disheartened. Indeed, one can make a case that exposing the fragility of the Commission is nothing new, and that this event means governments have a much stronger hand in enforcing change ahead of the European Recovery Fund’s foundation.

Retail investors find their voice, and give hedge funds a bloody nose
If the US consumer electronics retailer GameStop was not a stock familiar to you at the beginning of 2021, it’s much more likely to have entered your consciousness now. At the end of 2020, GameStop traded at around $10 a share, and looks destined to be another retail casualty. Last week, its share price peaked at $469, before ending the week at $325. Coordinated buying from members of the /r/WallStreetBets forum on Reddit turned the company into an online sensation, wreaking havoc on hedge fund ‘short sellers’ in the process.

Certainly, there are some non-financial motivations for the mass buying. Getting one over on mighty hedge funds is no doubt thrilling for the small investor. But the GameStop episode highlights the growing voice – and relevance – of individual retail investors. With personal investment technology now widespread, people are no longer bound by heavy entrance fees or institutional barriers to the market. Moreover, coordinating their trades by means of internet forums, gives them the power to move share prices almost at will. With the pandemic leaving many with rising cash savings and barred from everyday activities, activist day trading can seem mightily appealing.

It also exposes real problems for hedge funds in particular. Fund managers may hope that forums like WallStreetBets are banned or regulated for their role in potential ‘market manipulation’, but short sellers hardly have much of a leg to stand on here, given their predilection for banding together to accelerate the demise of a seemingly doomed company for their own profit, and that of their investors. What’s sauce for the goose is sauce for the gander, and perhaps will encourage hedge fund managers to think twice before targeting their next shorting opportunity. Not only can ‘flash mob’ purchases lead to damaging market swings, but individual retail investors are also much less likely to engage in the stock lending practices that hedge funds rely on to operate. If equities are in the hands of those unwilling to lend them out, liquidity dries up for short-sellers and they must scramble to cover positions, further amplifying the short squeeze dynamics that drive the prices to stratospheric heights.

In the short run, we suspect these dynamics will lead to some risk aversion from short sellers, potentially buying more cover for their positions. In the long run, the biggest risk and potential damage is likely to be for those internet buyers who jump on the bandwagon late. As with any gamble, eventually your luck runs out.

Why the UK labour market is key to the post-pandemic economic recovery
According to the Office for National Statistics, the UK unemployment rate hit a four-year peak in November, with 1.72 million people (5% of Britain’s workforce) looking for a job but unable to work in the three months to November. For the worst recession in living memory, that figure is better than expected. With the vaccination programme well underway, and the second half of the year looking brighter than the first, it is a decent enough starting point. But as always, there are complications.

According to the Economic Statistics Centre of Excellence, 1.3 million foreign-born workers (appr. 3.75% of the workforce) left the UK between July 2019 and September 2020. Brexit impacts and a COVID-ravaged economy forced the exodus, which hit London’s ‘domestic’ demand particularly hard. Almost 700,000 of leavers came from the capital, meaning London lost nearly 8% of its population in just over a year, hitting the businesses supplying their day-to-day needs. In normal times, this free flow of labour could be a positive for businesses, suggesting a workforce pool able to respond dynamically to decreased demand. But with post-Brexit immigration rules and no clear end to the pandemic in sight, this could become a permanent demographic shift, leading to a shortage of labour. That would be difficult for businesses, but the remaining workforce should benefit relatively. And, once an economic recovery is underway, you would expect Britain to be able to attract labour from elsewhere if needed. But politics complicates the situation. With its new points-based immigration system, the Government may not be quick enough to spot supply gaps, or be able to replicate the benefits of market forces regulating a natural free flow of people.

Age disparity is another big factor. Inequality between age groups was a theme long before the pandemic, but like many issues, has been accelerated by the virus. Job losses have hit the under 50s – and particularly under 25s – hardest. There are many reasons for this, with younger workers much more likely to be employed in virus-hit sectors like hospitality, as well as having less stable or senior positions. But the result is a more uneven labour market and greater inter-generational inequality. The perceived direct health threat from the virus is clearly lower for younger people, and yet in aggregate they have shared a heavier economic burden and will be last in line to receive vaccinations (and perhaps even the last to regain old freedoms). This is likely to increase the political divide between generations that has become so acute in recent years, with the potential of leading to a boiling over of tensions, towards social unrest as we saw in the Netherlands last week.

Addressing these problems is no easy task, but an extension of furlough and other emergency support schemes is sure to be the first port of call. The silver lining to the grim 2021 we have had so far is that the virus has forced Government budget hawks back into retreat. But unfortunately, emergency support cannot last indefinitely. At some point, we will see the full extent of the damage to Britain’s labour market. Until then, policy will be crucial to avoiding the worst of it.

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