John Husselbee

Lessons from 1709’s Great Frost

John Husselbee

Key Points:

  • The UK’s 9.9% GDP contraction in 2020 was the worst in more than 300 years, since a Great Frost laid waste to most of Europe in 1709.
  • While GDP struggled to recover for a decade after the Frost, we are not predicting anything like such fallout this time around. The UK’s economy is expected to grow at the fastest rate since the Second World War this year, based on a cocktail of successful vaccine rollout, pent-up demand being released, and ongoing fiscal and monetary support.
  • On the Liontrust Multi-Asset team, we are positive on UK equities amid the global reflation trade, citing cheap valuations, plenty of potential cyclical upside, and structural biases to sectors such as financials, energy and materials, which have been outperforming this year after a difficult 2020. Long-term Brexit impact remains the great unknown.
  • We continue to own growth and value funds investing in the UK, tilting between these to take advantage of opportunities.

 



Coming into 2020, few economists would have expected to be comparing the impact of a global pandemic (plus Brexit) against several months of frozen misery in 1709 and its aftermath – but that was exactly what happened as the UK’s GDP slumped 9.9% over the year.

This was the worst 12 months Britain had seen since a catastrophic winter more than 300 years ago – dubbed Le Grand Hiver in France – which laid waste to much of Europe, from Italy to eastern Russia. In the early part of 1709, the continent effectively froze, literally overnight on 6 January, and stayed that way for several months: people were skating on the canals of Venice, lagoons turned to ice in the Mediterranean, bells broke when rung and travellers could apparently cross the Baltic Sea on horseback. With temperatures as low as -15°C for a protracted period, this was the coldest winter in the last 500 years; British meteorologist William Derham wrote, ‘I believe the Frost was greater (if not more universal also) than any other within the Memory of Man’.

One of the most commonly posited reasons for this is a phenomenon called the Maunder Minimum, which happened between 1645 and 1715 and is described by NASA as a time when the sun entered a quiet phase. With less activity across the surface of our primary heat source, temperatures basically dropped across everything on which the sun was shining.

In other tales – some likely apocryphal, all apocalyptic – trees exploded as their sap froze, flocks of birds died in mid-air and plunged to the ground, and people turned to blocks of ice in their beds and were impossible to move. What cannot be denied, with grim echoes of the last year, is that this extreme cold, followed by food shortages and outbreaks of flu and plague, caused hundreds of thousands of deaths.

In the UK, the Great Frost gave rise to one of the largest fairs ever on the River Thames, which had become a ‘solid rock of ice’ according to one newspaper, as Londoners gathered to drink, skate and make merry. This did not last, however, and when the ice finally thawed, widespread flooding was hugely damaging for a largely agricultural economy. Crops were destroyed, grain prices soared and many communities were faced with starvation and ruin. All in all, figures suggest per capita GDP dropped by close to a quarter – overall GDP was down 13.3% in 1709 and 9.1% in 1710 after a 15.3% War of the Spanish Succession-driven decline in 1706 – and did not fully recover for a decade.

Largest annual GDP contractions in UK since 1701

While the 2020 contraction for the UK was the heaviest for 311 years – and worse than during the two World Wars, the Great Depression and the global financial crisis in between – we are certainly not predicting anything like such longevity of fallout this time around. We are currently positive on the UK, at least from an equity perspective; with conditions increasingly shifting against more speculative growth and technology companies, including rising bond yields, we continue to highlight the market as an attractive option amid the global reflation trade. Positive factors include cheap valuations, plenty of potential cyclical upside, and structural biases to sectors such as financials, energy and materials, which were weak in 2020 but have been outperforming the general market so far this year.

Stock markets tend to function as giant discounting mechanisms, running at least six months ahead, so no one should have been surprised, despite the surging FTSE, to see figures showing the UK economy back in reverse gear during January. This was the first full month under renewed national lockdown conditions and the resulting 2.5% contraction was considerably better than the near 5% decline predicted by many. Showing further encouraging signs, GDP was up 0.4% in February and an estimated 2.1% in March as schools reopened, with the overall Q1 decline of 1.5% described as a Houdini-like escape and a strong bounce also expected in April.

Better figures are inevitable as the economy continues to reopen and the UK remains at the forefront of the vaccination effort, with close to 60% of adults having had at least one jab as we near the end of May.

As a caveat, however, we have to give due focus to Brexit and what impact it might ultimately have. Office for National Statistics data for January revealed the largest monthly fall in goods imports and exports for the UK since records began in January 1997. It also charted a 41% decline in exports to the EU during the month, valued at £5.6 billion, alongside a £6.6 billion (29%) fall in imports from the euro bloc. Meanwhile, close to a quarter of small UK firms have temporarily halted sales with the EU because of post-Brexit rules, according to a Federation of Small Businesses report in March. Brexit finally being in the rear-view mirror, after more than four years of wrangling, is a key reason we are increasingly positive on UK equities but the full implications of leaving a trading bloc after close to half a century will only be fully clear in the months and years ahead.

Turning to more bullish thoughts, predictions released in April claim the UK’s economy will grow at the fastest rate since the Second World War this year, based on a cocktail of the successful vaccine rollout, pent-up demand being released, and ongoing fiscal and monetary support. The EY ITEM Club (standing for Independent Treasury Economic Model) expects GDP to grow by 6.8% in 2021, which would be the fastest surge since 1941. After the Great Frost-eclipsing 9.9% contraction in 2020, the worst in the G7, this growth would pull the country back to pre-pandemic levels by the middle of next year.

Howard Archer, chief economic adviser to the ITEM Club, said the latest forecasts indicate less permanent scarring for the economy than expected and also predicted that the peak in unemployment will be lower than feared and lower than following any downturn in the last 30 years. Using the Treasury’s economic models, the ITEM Club said it expects unemployment to reach 5.8% by the end of 2021 and 4.5% by the end of 2022. For context, the rate was 4% before the pandemic struck.

Elsewhere, the Bank of England is similarly, and even slightly more, optimistic for the UK’s prospects this year, predicting 7.25% growth, although Governor Andrew Bailey warned against getting too carried away; this effectively gets the country back to where it was before Covid and two years of output growth have been lost. Later analysis revealed this strong upward revision was based entirely on better-than-expected growth in the first quarter, however, with a downgrade to the outlook for the subsequent nine months. FT analysis shows the Bank has actually become gloomier about the pace of recovery until 2023, with cuts in expected growth in every quarter from April to June 2021 until the end of 2022.

Given this, and assuming the recovery continues as expected, there are a couple of things to watch over the course of this year and beyond. In line with other central bankers, Bailey warned inflation may get ‘a bit bumpy’ as base effects come in and out – and it has already doubled to hit 1.5% in April – but said there is little reason to panic over the medium term. With plenty of attention on potential policy tapering, the Bank has also decided to slow the pace of asset purchases under the quantitative easing programme to £3.4 billion a week, from £4.4 billion, but again stressed this is an operational decision and should not be interpreted as a change in policy. For now, policymakers have also voted unanimously to keep the bank rate unchanged at a record low of 0.1%.

To recap, the UK was hit from all sides in 2020 with the impact of Covid, sector composition (heavy in struggling resources, financials and energy), and Brexit uncertainty combining to make it the most unloved major market. Despite its global revenue base, we believe there is too much pessimism in the price so, tactically, this is an attractive market, although a strong pound may take the shine off large-cap earnings.

In any region, we typically tend to own growth, value and core/index funds, tilting between these to take advantage of opportunities. On the growth side, we highlight Lindsell Train UK Equity, with manager Nick Train typifying a low turnover, consistent approach and never deviating from his quality growth bias in seeking brands that can survive and thrive over many years. Train tends to focus on companies with proven track records of generating high and consistent returns on equity, typically consumer staples, select media names and financials (ex-banks and insurers), as well as businesses embracing and using tech to their advantage.

Moving to the other end of the spectrum, JOHCM UK Dynamic is a value fund, with manager Alex Savvides focusing on companies that are undergoing change and currently seeing ample opportunities in the UK owing to Brexit concerns abating and under-ownership of the market by the investment community. As would be expected, Savvides’s contrarian style has been rewarded in the value rally since vaccines were announced in the autumn of 2020.

Reflecting the shift in markets, for the Multi-Asset Funds, we recently took some profits by trimming Lindsell Train UK Equity after a strong 2020 and added to JO Hambro UK Dynamic. Both managers remain positive on their styles, however, with Savvides noting that UK equity valuation dispersions are at levels last seen in the 2000 tech boom and this is providing opportunities to increase some of his higher conviction positions and boosting confidence that the portfolio can outperform regardless of changes in macro conditions.

Train, meanwhile, has been keen to stress his fund is not full of ‘steady plodders’ after a weaker first quarter of 2021 as economic and investor confidence recovered. While continuing to see the benefits of more defensive names like Unilever, left behind for now as there are recovery stories to chase, he also noted encouraging share price gains from holdings such as Burberry, Daily Mail, Sage and Schroders, which all have potential to deliver business growth as economies and stock markets, particularly the UK, improve.

After a challenging period for UK equities, signs are that the sun is rising on this market; or to say the very least, in economic and investment terms, we do not appear (to quote the Duchess of Orleans, sister-in-law of King Louis XIV back in 1709) to be facing cold ‘so fierce that it defies description’.

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Tuesday, May 25, 2021, 8:40 AM