All is vanity

Depending on your point of view, Twitter is either a moral cesspit or a source of great inspiration. I can see both sides but as a free source of insight from some outstanding academics and journalists it is hard to beat (though sometimes you do have to wade through a lot of nonsense to find it). The news this week that Elon Musk’s $44 billion bid to buy Twitter has been accepted has raised more than a few eyebrows, generating concerns that the self-styled “free speech absolutist” will turn the platform into even more of a hell-hole than many people already believe it is.

Musk has not always been such a fan. Some years ago he was quoted as saying, “I don't have a Facebook page. I don't use my Twitter account. I am familiar with both, but I don't use them.” When he did finally venture onto Twitter in 2018, his Tweets suggesting that he was contemplating taking Tesla private earned Musk a $40 million securities fraud charge from the SEC. Undeterred by his past experience, the online payments guru turned car-maker cum space explorer appears to be following in the footsteps of 1970s entrepreneur Victor Kiam whose memorable marketing catchphrase for Remington shavers was “I liked it so much, I bought the company.”

Twitter's glory days may be behind it

The motivation for Musk’s involvement remains unclear. The social media segment is increasingly competitive and depending on how it is defined, Twitter does not even rank in the global top 15 most popular social networks. Growth in the number of active Twitter accounts has slowed sharply in recent years, having grown at single digit rates since 2015. Twitter’s preferred metric these days is Monetizable Daily Active Usage (mDAU) which is a measure of users who have logged into the platform and been exposed to adverts. After global mDAU gains of 21% and 27% in 2019 and 2020 respectively, this slowed to 13% in 2021 (chart). More worrying is that growth in the critical US market slowed to 2% last year versus 15% elsewhere. Twitter has been tight-lipped as to whether the slowdown in US activity is anything to do with the January 2021 ban imposed on former President Donald Trump. Whatever the reason, Twitter recorded a second consecutive annual loss last year, with cumulated losses of $1.36 billion over 2020 and 2021.

 

Financing the deal 

The financing arrangements of the buyout are also worthy of comment. Under the terms of his proposed deal, Musk will finance the buyout with $13 billion of debt, $12.5 billion secured against Tesla stock and $21 billion of his own equity. Musk is thus financing more than 70% of the deal from his own funds which runs contrary to standard LBO wisdom in which borrowing is mainly secured against the assets of the target company. There are suggestions that the lending banks are limiting their participation due to concerns that Twitter’s revenue stream has limited growth potential. Moreover, the company’s debt ratio, calculated relative to shareholder’s equity, has been creeping up since 2019, rising from 0.46 to 1.29 by Q1 2022. Even though the debt component of the deal is relatively limited, adding $13 billion of liabilities to the existing $4.2 billion of long-term debt would raise Twitter’s debt ratio to 3.5 which is significantly above the S&P500 average of 1.5 (chart below). Conducting a buyout in a rising interest rate environment will pose additional problems.

A highly indebted company with limited revenue growth potential does not look an attractive investment proposition. Moreover, the fact that the portion secured against Tesla stock takes the form of a margin loan means that if a margin call is triggered, Musk could be forced to sell Tesla stock to meet his commitments. This risks putting downward pressure on Tesla’s price. Roughly speaking, Musk would be on the hook if Tesla stock fell by 43% from the price prevailing on the filing date of 20 April. For the record the price is down 12% in a little over a week, and the trigger point is consistent with the price prevailing in November 2020. The plan to buy Twitter thus poses unnecessary risks to Tesla, which is now a very profitable business with one of the widest profit margins in the auto industry. But if Tesla is so successful why might we expect a price fall? For one thing the rally over the last couple of years has been remarkably strong, which is always a reason to be concerned about a pullback. Second, if Musk becomes distracted by running Twitter and takes his eye off Tesla’s operations there is a risk that any problems experienced by the carmaker are initially missed or become more difficult to fix.

Can Twitter be monetised?

Aside from concerns about the financing of the deal, the episode raises a lot of interesting questions about the valuation of digital content. For a platform such as Twitter, its value is embodied in its network. In theory, Metcalfe’s Law states that a network’s value is proportional to the square of the number of nodes in the network. Thus a network like Twitter with 300 million users has an inherent "node value" of 90 quadrillion. If these were dollars, Musk would be laughing all the way to the bank But monetising Twitter's reach will prove extremely difficult. Even a small subscription fee is likely to deter many users - demand is highly price elastic. Besides, imposing a fee is inconsistent with the vision of Twitter as a “digital town square” as former CEO Dick Costolo once called it. According to media reports, Musk told banks that agreed to help fund the takeover he would crack down on executive pay to slash costs, and would develop new ways to monetize tweets. Maybe Musk does have a plan to generate money from Tweets, but it is not immediately obvious to the many analysts who follow the company.

At this stage of proceedings the financials of Musk’s Twitter deal do not look compelling. Short of a radical overhaul of the business model it is difficult to see how the company can generate the returns which would justify paying $54.20 per share. The fact that the board is prepared to sell at a price 25% below last summer’s high may tell us something about how they view the future. If the deal does go ahead – although it is far from certain that it will – it may go down in history as a vanity project demonstrating the old adage “buy in haste, repent at leisure."

Good days, bad days

Market volatility is a simple fact of life – it is always with us and as a consequence we just have to deal with it. Sell side financial institutions like it because higher volatility prompts corporate and retail investors to look for some form of asset protection, giving them the opportunity to write more tickets. They also like it because it is possible to make very decent returns if you time the entry and exit from your positions correctly. Conversely, retail investors hate it because their portfolio value can whip around without any obvious fundamental explanation.

How the professionals deal with volatility

Equity volatility is conventionally measured using the prices of index options with near-term expiration dates. The global benchmark is the VIX, which measures volatility for the S&P500. It is currently trading at 22, which is slightly above its long-term average of 19.5 based on data back to 1990 (chart above). This is not excessively concerning. Indeed, as I have noted on previous occasions (here, for example) markets have been far too complacent in recent years as central banks have anaesthetised them with their huge asset purchase programmes. Given the exceptional uncertainty surrounding the economic outlook in the Covid era, it is probably a good sign that volatility is perceived to be slightly above average.

Excessive volatility spikes are rare: We have experienced only a couple of major volatility surges in recent years – once in the wake of the Lehman’s episode in 2008 and another in 2020 as the Covid crisis began to unfold. Institutional investors can hedge some of the risk by investing in an Exchange Traded Fund (ETF) which moves inversely with the VIX. Such indices are only suitable for short-term hedging purposes – those who try a buy-and-hold strategy tend to get burned very quickly. This makes them unsuitable for retail investors who seek more durable protection.

Avoiding the downside yields bigger returns than chasing the upside

As it happens, one of the better protection methods is abstinence. To demonstrate the impact of volatility on investor positions I looked at daily equity market data going back to 1990. Starting with the S&P500 I calculated what would happen if investors missed out on the days with the biggest gains and losses and assumed that on those days the portfolio value reverted to the level prevailing in the previous period. Arbitrarily assuming that investors missed out on the 30 biggest single daily gains, a portfolio which tracked the S&P500 since 1990 would be almost 83% below one which included all trading days. By contrast, excluding the 30 biggest daily losses would have resulted in a seven-fold increase in portfolio value. Putting these two factors together by taking out both the top 30 increases and decreases, the index would have ended up almost 22% higher than one based on the S&P500 alone (chart below). The results are broadly similar for the FTSE100: excluding the largest 30 daily gains and losses resulted in a gain of almost 14% versus one based purely on the benchmark.

In theory we can extend our analysis for the S&P500 back to 1928 without materially changing the results although the volatility in the index during the 1930s means that more than half the biggest daily swings occur before 1940. Arguably the macro environment today is very different to that in the 1930s with economic policy much more sensitive to market volatility. Accordingly it seems reasonable to exclude the 1930s from the calculations. Running the calculations since 1940, and maintaining our exclusion threshold to encompass the top 30 gains would lead to an 85% loss but excluding the top 30 losses would increase the value of our portfolio ten-fold. Excluding both the highs and lows would increase our portfolio value by almost 60% compared to the benchmark over the last 81 years.

If you don’t have perfect foresight, hedge

This demonstrates two key takeaways: (i) big movements in indices have a disproportionately big impact on future gains, perhaps because they trigger sentiment shifts which generate a change in market direction and (ii) avoiding the worst excesses of decline have a bigger impact on portfolio returns than chasing the big gains. Obviously the foresight to know when we are about to experience a massive correction is not gifted to most of us, therefore the best we can do is to hold a balanced portfolio comprised of assets whose prices are either inversely correlated with equities or not correlated at all. As I noted last summer, the 60:40 portfolio strategy which comprises 60% equities and 40% bonds is as good a way as any to hedge risks.

The upshot of all this is that investors who pursue a minimax strategy (minimising maximum losses) are likely to outperform those who follow a maximax strategy (the aggressive maximisation of gains). Indeed the latter is viewed by many in the media as the way in which sell-side investment operates and some hedge funds still publicly hail such an approach as the ideal investment strategy. But a maximax strategy is like building a football team comprising only strikers. Whilst strikers score the goals and grab the glory, the team is unlikely to win anything unless the defence is strong enough to repel the opposition. In football terms a minimax strategy allows the team to build a stronger defence which will allow them to be more successful over the longer term. When it comes to portfolio investment we cannot eliminate our exposure to volatility but we can take steps to reduce our exposure to it. As in other areas of life, buying some protection can considerably reduce our long-term costs.

A second wave comes crashing down

Markets have been unsettled for some time about the prospect of a second Covid wave and they finally capitulated this week. The market collapse on Wednesday, which saw the S&P500 fall more than 3.5% and the DAX fall more than 4%, came on the day that Germany introduced a stringent set of national lockdown restrictions involving a one-month shutdown of bars and restaurants which is due to come into effect on Monday. France also announced a national lockdown which came into effect today. It may not be quite as stringent as that enforced earlier in the year but it is still pretty drastic. As President Macron said in his TV address, “the virus is circulating in France at a speed that even the most pessimistic forecast didn’t foresee … The measures we’ve taken have turned out to be insufficient to counter a wave that’s affecting all Europe.” Given the renewed spread of the disease, it seems only a matter of time before the UK is forced to follow suit.

What does a second wave mean for the global economy? Throughout this year, most reputable forecast institutions have presented a range of alternative scenarios around the baseline and it is worth digging into some of the details of the IMF’s forecast released last week. The IMF baseline looks for a 4.4% contraction in global GDP this year followed by a rebound of 5.2% in 2021 (in my humble opinion this sounds like a stretch since it implies that all the damage done to output in 2020 will be recouped next year). However, whilst the downside scenario garnered rather fewer headlines it was nonetheless illustrative. It is based on the assumption that Covid proves difficult to contain, with a significant drag on activity in the second half of 2020 extending into 2021. In addition, the IMF assumes that progress on finding effective treatment is rather slower than currently assumed, with a delay in the process of finding a vaccine and the requirement that social distancing measures have to remain in place for a long time to come.

Under these circumstances the global growth rate next year could come in as low as 0.9% versus the baseline projection of 5.2% and it takes until 2025 before output is back on the path implied by the baseline (chart 1). It is also notable that in this scenario emerging markets take a larger than proportional hit. This accords with my long held view that since EMs are acutely dependent on a recovery in their main export markets, the IMF is too optimistic on how quickly output in Asia will rebound in the baseline projection.

As far as markets are concerned , we have been here before. The equity declines registered on Wednesday may not be the biggest daily falls this year but they are not far away from some of the dramatic swings recorded in March. On the one hand there is some scope for cautious optimism in that we have a rather better idea of what we are letting ourselves in for. Accordingly, equity indices may not fall as sharply since we are operating in less unfamiliar territory. Against that, markets may be on the verge of capitulation as the pandemic proves not to be the short, sharp shock that was expected in the spring. As is usual at times of equity market stress the tech sector comes in for the closest scrutiny (chart 2). In addition to concerns that the pandemic may take the edge off demand, the fact that Apple’s iPhone sales and Twitter’s user growth both missed estimates added to the sense of market uncertainty. Next week’s US Presidential election may have longer-lasting consequences for the tech sector if Joe Biden is elected to the White House and embarks on a programme of cutting the tech companies down to size.

However, for the time being I tend to take a more optimistic line. For one thing we should not read too much into equity volatility just a few days ahead of the most important US election for years. Part of the recent wobbles may reflect some position squaring ahead of the main event. Moreover,  central banks are pumping in liquidity on an unprecedented scale. The Fed has increased its balance sheet by two trillion dollars this year, primarily due to purchases of Treasury securities which will suffice to keep bond yields at ultra-low levels. Here in Europe, current estimates suggest that EMU governments will issue €1.2 trillion of gross debt next year but maturing bonds and interest payments could reduce the net figure to €405bn. Even without the promised monetary expansion the ECB is expected to buy €460bn of debt in the secondary market – more than planned issuance. This downward pressure on global yields when plugged into a simple discounted cash flow model ought to be enough to put a floor under equity markets.

But even if markets do hold up, the economy will take a long time to recover from the scarring effects of Covid. In the US, for example, the unemployment rate currently stands at 7.9%, twice as high as in February prior to the pandemic whilst employment is around 11 million below pre-recession levels. What makes me somewhat uneasy is that we have entered a period where there is a mounting disparity between what is happening to markets and conditions in the real economy which underpin them.

This will be manifest in elevated P/E ratios. I have frequently referred to the Shiller trailing 10-year P/E ratio for the S&P500 as a measure which smooths out cyclical variations and have noted that over recent years it has remained very high in a historical context (chart 3). In just the last few months it has rebounded back to pre-recession highs following a dip in the wake of market panic in March. This is a clear illustration of the extent to which traditional valuation metrics no longer apply and for the foreseeable future the equity market will be running on the back of the support given by central banks. Given the lack of clarity from the normal pricing metrics it could be a very bumpy few months for markets.

A highly technical rally

As the summer draws to a close the S&P500 continues to power to new highs, contrary to expectations earlier in the year when it looked like the corona effect would change the business model, if not forever then for a very long time. The benchmark US index looks set to post its best August performance since 1986. But trends in aggregate indices are not necessarily a good guide to what is happening in corporate America.

The focus of attention of late is the contribution of tech stocks to the surge in US markets. This was brought into sharp focus last week when Apple became the first company ever to post a market cap of USD 2 trillion. The company’s market cap has increased by almost 118% since the March trough, followed not far behind by Amazon whose market cap is up by 104%. At the start of the year, the FAANG sector accounted for 14.1% of the S&P500 market cap; today it stands at 19.8% and since March these five companies have contributed 25% of the increase in the index.

That is a very powerful motive force behind the surge in the aggregate index but the S&P average increase is a much lower, although still-healthy, 65% from the trough. The recovery since March has been described in some quarters as a K-shaped recovery with an increasing divergence between the top performing stocks and the worst performers. It is thus becoming increasingly obvious that this is an unbalanced US rally which is dependent on a small number of stocks. In that sense it is reminiscent of the surge in the late-1990s which proved unsustainable when the tech bubble burst.

One key difference, however, is that the FAANG stocks today have a deliverable product and a proven business model. Investors are not buying companies that offer the promise of a product at some point in the future. Amazon acts as the world’s global market place with a delivery system that can ensure that nearly anything you want can be brought to your door. That said, investors are prepared to pay a very high price to hold the stock of these digital disruptors and price metrics paint a more nuanced picture of the sector. The S&P500 as a whole is trading on a P/E multiple of 27.2x expected 2020 earnings, well above the 21x at the start of the year, but this is distorted upwards by the tech sector. Whilst Google and Facebook are trading at current year multiples of 32x, Apple is at 39x and Amazon and Netflix are running at 71x and 74x respectively (chart). Clearly the surge in FAANG is being driven by a strong earnings performance in recent months, but a lot is priced in for the future and some parts of the tech universe look more expensive than others. I can see why investors are keen to pay a premium for Amazon given the way it is shaping the face of retail, even though it looks very expensive, but Netflix?

From an investor perspective, current trends do not suggest buying an aggregate index tracker since a FAANG index contains all the stocks which are driving the market. Against that, a portfolio diversification argument would caution against putting too many eggs in one basket. Nonetheless it puts the European performance into perspective and perhaps the apparent underperformance of the FTSE100 is a better reflection of average corporate performance than the red hot S&P500.  In that light, it is notable that a recent report from Bank of America pointed out that the market cap of the US tech sector alone stands at $9.1 trillion, which is bigger than the market cap of all Europe ($8.9 trillion).

As one who has watched markets boom and bust a few times over, the surge in tech stocks should remind us of Stein’s Law, articulated by the economist Herbert Stein, that “if something cannot go on forever, it will stop." Or to paraphrase, if a trend can’t continue, it won’t. What this ignores, however, is the timing problem. You bet against a bull market like this at your peril because, as the old adage has it, “the markets can remain irrational longer than you can remain solvent.” With yesterday’s news that the Fed is effectively committing to low interest rates for a very long time to come (I will come back to this another time), debt is simply not going to act as a major constraint on company actions.

At some point, there surely has to be some form of reckoning even if monetary policy is not going to be the catalyst for a market sell-off in the coming years. But what might be the trigger? It is possible that investors will simply rotate out of tech at some point, especially if Covid becomes less of an economic threat (perhaps because a vaccine is developed). This might lead the tech sector to underperform vis-à-vis the “old economy” rather than collapse outright. Geopolitics could play a role if the US-China spat were to heat up. But perhaps the most likely catalyst is that governments start to make good on their promises to introduce a digital tax, particularly in Europe. The US also has a history of breaking up monopolies and history buffs will recall the breakup of Standard Oil which fell foul of anti-trust legislation in the early twentieth century whilst as recently as the 1980s, the Reagan administration took the axe to AT&T.

That certainly will not happen if Donald Trump is re-elected and it is even doubtful that a President Biden would want to go down that path, especially since his running mate Kamala Harris is perceived as very tech friendly. But in this crazy world, we have learned never to say never.

Don't give up on the tried and trusted

There is a considerable degree of trepidation as we head into the Q2 company earnings reporting season. It is obvious that earnings will have taken a huge hit as consumer demand collapsed across the board. However, the main focus will be on guidance as investors treat the last three months as bygones. Dow Jones reported at the start of July that 157 S&P500 companies had reduced their outlook as of end-June with just 23 providing upgrades, whilst 180 have pulled them altogether which suggests that markets will be flying blind for a while to come.

Current consensus estimates point to a fall of around 30% in S&P500 Q2 earnings relative to Q1, which follows a 15% decline in Q1. If realised, this will put Q2 earnings around 45% below year-ago levels. Even assuming a rebound in the second half, the consensus suggests we are set for a 25% decline in 2020, which would be close to the 28% decline registered in 2008. It would not take a huge miss on the numbers to record the worst year for US corporate earnings since the 1930s (chart 1).  Moreover the concern is that the consensus is overstating expectations for an earnings rebound. In the wake of the 2008 crash it took more than three years for earnings to get within 10% of the previous cyclical high. This time around, the consensus view is that it can be achieved within 18 months.

 

Valuation metrics also look elevated as markets are priced for perfection. The one-year forward P/E ratio on the S&P500 is trading above a multiple of 25 and the price-to-book ratio is at 3.65 versus a long-term average of 2.65. Under normal circumstances such indicators would set the alarm bells ringing but as we are all too well aware, times are not normal. Discounted future cash flows have been boosted by central bank actions to cut rates to zero, and on the expectation they will not rise anytime soon it is logical that equity prices should rise. The lack of returns in other asset classes further raises the attractiveness of equities. Even sectors which have performed strongly over the past decade, such as property, are struggling. Whilst stocks may look over-bought and there are clearly risks associated with both the earnings and economic outlook, investors cannot bring themselves to bet against a strategy which has worked so well in the post-2008 world.

This impact of low interest rates and their effects on equity markets has once again raised questions of whether the traditional 60/40 portfolio rule is fit for purpose. This famous investment rule of thumb suggests investors should hold 60% of their portfolio in stocks and 40% in lower risk securities such as bonds. In theory this should produce long-term average returns which match equities but by allocating a sizeable chunk to bonds it smooths out the extreme highs and lows associated with an equity-only portfolio. The evidence suggests that this strategy has outperformed over the past 20 years. Using a portfolio in which the available assets are global equities, US Treasuries, the GSCI commodity returns index and an estimate of cash returns in the industrialised world, the 60/40 portfolio generated an average annual return of 4.9% between September 2000 and June 2020.

It has not always been the optimal portfolio. Immediately prior to the Lehman’s crash, the 60/40 portfolio was one of the poorer performers largely because it took no account of the commodity boom that was building at the time. Indeed, I well remember being told in 2006-07 that no self-respecting portfolio manager could afford to ignore commodities because returns were uncorrelated with other financial assets and consequently they enhanced portfolio risk diversification. How times change: Commodities are down 84% from their peak achieved in summer 2008 and they have proven poisonous to investor returns. The 60/40 portfolio has outperformed both safe and risky structures which assign varying non-zero weights to commodities and cash. Moreover, as the Credit Suisse hedge fund returns index shows, this simple strategy has matched hedge fund strategies in recent years which – given what investors pay hedge funds to manage their money – is a poor show on their part (chart 2). All told, on a 20 year horizon the 60/40 strategy has generated higher returns once hedge fund fees are taken into account.

This is not the first time the 60/40 strategy has been called into question – it seems to arise every time one or other of the markets appears out of whack. On this occasion low interest rates mean that the returns from bonds are likely to look very poor for years to come. But investors tempted to overweight equities, which are likely to benefit as a consequence, run the risk of getting caught out by volatility as markets continue to question whether current price valuations are justified (we can expect quite a lot of that in the months ahead). Since the intention of 60/40 is to offset the extreme highs and lows of equities, it may be worthwhile sticking with it for a bit longer. It is after all, a tried and trusted method and that is not a bad thing in our new, uncertain investment world.

The storm before the tsunami

To say it has been a wild market ride today would be an understatement. Based on daily data back to 1985 (a total of 9179 observations) the 7.7% decline in the FTSE100 is the fifth largest correction in recent history, beaten only by double digit declines in the wake of Black Monday in 1987 and two days of correction in October 2008 as the Lehman’s fallout continued to reverberate. The 7.9% decline in the DAX was also the fifth largest correction in the German equity market although the US correction did not even make the top 10.

I have been through a few market corrections in my time, and each of them was triggered by a unique set of circumstances. Today’s moves, however, were only partly initially related to equities. They were triggered by the 30% collapse in the oil price following Saudi Arabia’s decision to launch an oil price war and were exacerbated by coronavirus concerns. The Saudi decision came after Russia refused to join OPEC countries in extending existing production curbs in a bid to drive oil prices higher and the Saudis are clearly trying to force the Russians back to the negotiating table. This is bold and risky strategy. Whether or not it works, the shock decline in oil prices put initial pressure on the oil majors and triggered a broader market selloff at a time when sentiment was already extremely nervous. Momentum effects then took hold as equities competed to go ever lower.

Faced with this kind of environment, there is nothing anyone can do but stand back and watch the carnage unfold. Interest rate cuts will be of no real help, even though the Fed, ECB and BoE are likely to deliver additional monetary easing before the month is out. Policymakers can perhaps impose bans on short-selling or impose circuit breakers on the market which will temporarily limit the downside but they are on the whole powerless. The flip side of the equity selloff has been the surge into safer havens such as government bonds and gold, with the US 10-year Treasury yield falling to a new all-time low of 0.5% and the 10-year German Bund trading at -0.86%, implying that investors are so keen to preserve their capital that they will accept a negative return on their holdings of sovereign German debt because the expected loss of principal is greater than the negative yield on Bunds. Without wishing to be too gloomy, a lot of countries are now apparently at much greater risk of recession than perhaps we thought a week ago.

In the face of an equity correction of today’s magnitude, it is easy to extrapolate into the future and make the case for further huge declines. But much depends on the nature of today’s shock. If it merely represented a kneejerk reaction to the oil collapse which got out of hand, markets could easily rebound a little in the near-term. But if it reflects concerns about the impact of the coronavirus on the wider economy, which is more likely, I would expect a lot more downside before we reach the bottom. I noted in this post that the US market had the potential for another 10-20% downside. The market is already 7% below where it was when I wrote that, and as the number of non-Chinese virus cases continues to increase, the potential for economic disruption continues to grow.

The fiscal response

With monetary policy all but exhausted, governments will have to step up to the plate to deliver measures to support the economy. We will have a great chance to see what the UK government is made of when it delivers its post-election Budget on Wednesday. Much of the very good pre-Budget analysis prepared by NIESR or the IFS has now been overtaken by events. It was originally planned that this would be a Budget which attempts to deliver more spending, particularly for those regions which have been left behind by austerity. This was to be a reset of policy – the so-called “levelling up”. But now it will be dominated by efforts to limit the impact of COVID-19.

There are essentially three areas that the government will have to address: (i) ensuring liquidity-constrained businesses can continue to operate; (ii) providing support for individuals who lose income and (iii) maintain the delivery of public services. There are various things the government can do: In the case of (i) more generous payment terms in areas such as employer social security contributions would help to limit the burden (e.g. a payments holiday whereby firms do not have to pay contributions for those workers who are sick with the coronavirus). To tackle issue (ii), the government could reduce the time it takes to get access to Universal Credit payments (as I argued here) and addressing (iii) might involve significant increases in the budget for the National Health Service.

As the IFS points out, in fiscal years 2008-09 and 2009-10, the government’s fiscal expansion package was equivalent to 0.6% and 1.5% of GDP respectively. That is a high benchmark but the UK does have the fiscal headroom to try something similar today. Other governments across Europe will have to follow suit. The German government, for example, has previously dragged its feet but there are indications that it is now prepared to boost spending to support companies which apply for aid to offset wage costs during labour layoffs. As the UK examples cited above show, fiscal policy does not necessarily have to take the form of big infrastructure spending programmes: tweaks to the tax and benefit system can provide much more targeted help.

The time for waiting is over with action required to at least prepare the economy for the worst case outcomes. There is after all, no point in the likes of Germany continuing to run surpluses for the sake of it. We should welcome any moves towards fiscal easing. For too long, governments have been absent from the fiscal policy fray and have left it to central banks to manage the economy. Whether it will mark the start of a more targeted approach, or whether we will soon revert to a period of retrenchment remains to be seen. But whatever else governments do, they must act soon. If nothing else, markets will ultimately punish them for failing to act.