Market Update from Jilly Mann
The move towards the global release from Lockdown restrictions is gathering pace this week, with Europe starting to tentatively ease their guidance, and the UK rumoured to follow suit from next week onwards. It is perhaps difficult to directly compare the UK with Europe as the Lockdown in parts of Europe has been extremely strictly imposed with much less onus on self-responsibility than perhaps has been shown in the UK. Nonetheless, how the respective populations respond to the additional freedoms as and when they arrive will provide key insight into how consumer spending, workforce disciplines and ultimately the ability to prevent, if not withstand a second wave of the virus will impact economic growth over the remainder of 2020.
So far Asia offers us the most insight and whilst it has largely warded off any immediate resurgence of the virus, it is far too soon to say that this won’t happen as social measures start to ease. One could cite New Zealand as a model to copy and whilst they seem to have handled the crisis well as a nation, one must consider that the relative size of their population and the density of their urban areas are much less akin to Europe and the UK than Asia.
To pick up a theme from a previous update, the civil claims against China have quietened down over the last couple of weeks, but it is disturbing to discover that senior US officials have actually considered defaulting on US debt to China as a means of forcing China to compensate the US for the financial impact of Corona Virus. Markets don’t appear to be taking this proposal seriously, but the fact that it has even been formally discussed raises questions about how many of these proposals are simply stunts designed to whip up a frenzy of US nationalism, i.e. America First, in an election year where President Trump’s one major calling card, the success of the economy, has hit the buffers. It is not in America’s interest to play these games. It causes unnecessary global unrest and were it to happen, it would cause US interest rates to spike and would damage the US’s global reputation amongst other debtors and would inevitably lead to China reneging on their agreement to purchase goods from the US.
Europe is facing its own political challenges as well, with the German Constitutional Court ruling that the European Central Bank (ECB) must justify its response to the Covid 19 crisis, which constituted an extensive bond-buying program. This ruling has only just happened and so it will take time to see where this particular story leads, but whilst this could constitute a further threat to the long term future of the Eurozone, there remains plenty of scope for short term recovery within European stocks which we are still in a position to take advantage of.
The US stock market continues to be propped up by technology stocks and so remains at what appears to be an unsustainably high valuation level. During Lockdown, as we adopt the “new normal”, technology has been a necessity, but it is a necessity which has stopped the S&P 500 from falling drastically on days when the likes of Warren Buffett, the American investment guru, sells airline stocks then struggles to find anything else to buy in the US at fair value and so keeps his powder dry in cash. This indictment on inflated US stock valuations would ordinarily lead to a sharp downturn in the market, but the FAANG technology stocks (Facebook, Apple, Amazon, Netflix and Google) keep picking up the slack.
The reality is that as we work through this crisis and the necessities of Lockdown relax, some of these technology stocks should also naturally retract. Netflix subscriptions shot through the roof in the first quarter of 2020, as people couldn’t go out and subscribed to Netflix instead. How many of those subscriptions will continue post Lockdown? Inevitably some, but not all.
Zoom Video Communications is another good example of a technology stock which has soared over the past year. During 2020 alone, the stock hit a peak of being up over 150% from its starting price at the turn of the year. It has slipped back a little over the past fortnight, but the figures are monumental. According to Zoom’s management reports, there were 10 million daily meeting participants using Zoom technology in December 2019, yet that mushroomed to 300 million daily meeting participants in April 2020. Even though the world won’t be returning to the old ways immediately, those numbers are unlikely to maintain such heights. Competition from alternative technology providers will increase. Price wars have already started amongst various online meeting providers; merger & acquisition activity is likely to happen as survival of the fittest or the race to win the most users takes hold; perhaps overwhelmingly though Zoom and other such technologies will have a place in industry to an extent that would not have happened for years without Covid 19, they won’t be the sole means of communicating forced upon us by the Virus.
I’m reading many reports saying how business and the world will change forever as a result of the Virus. I agree that the world will be different for some time to come, but it has become too easy in this social media age for every global event to lead to a superficial pronouncement of exponential change. Amongst our own team, who are largely ingrained in social media ways, the overwhelming desire now is to get back to the office and interact as a group. Technology carries us through so far, but it doesn’t replace the social interaction which people need on a daily basis. Technology can cut extensive travel times and extraneous physical meetings, but for many it won’t replace business travel and physical meetings in their entirety. Our view on technology is that we need it now, we have had to adapt to it to function through Lockdown and as traditional working arrangements resurge, we will still use it, just not as much as we are having to do so today. If that happens, one can expect technology prices to retrench from their current highs, not necessarily a protracted or deep fall, but a steady retrenchment to a level which better reflects how we will use technology when we have a choice over how and when we use it rather than simply having the need to use it. The Zoom story reflects this well, as the price has already come down from just shy of $170 per share in mid-April to $145 dollars today. When the time is right, I would expect technology funds to form a ballast in our portfolios for years to come, but right now we feel that unique circumstances are masking true values and they are simply too expensive.
Moving onto the UK, the reporting season is in full flow at the moment with inflation figures due imminently. The data won’t look good, but as we keep saying, who realistically expects it to be so. Inflation is something we need to keep a watch out for in our client portfolios. There have been too many false dawns over the last 20 years where the reliance on historic information has predicted inflationary trends where ultimately none were forthcoming. The introduction of Quantitative Easing in 2008/09 as a unique economic tool to flood the market with liquidity put paid to much of the benefit of looking back at historical trends. 2020 feels like it could pose a similar conundrum. Central Bank responses to the Covid 19 crisis should lead to a highly inflationary environment where we need to skew portfolios towards assets which would do well with higher inflation, but it is too soon to tell if this is another false dawn or if indeed we do need to adjust our holdings to protect against inflation. It is the very point which has been made about airlines today. When people start flying again with any great regularity, prices may initially fall to encourage people to buy tickets and get the industry moving again, but then prices could just as easily ratchet up shortly after to levels far in excess of pre Covid 19 levels. There are arguments for and against this happening, but we are too early in this phase of the virus to make that judgement with any conviction.
Finally, a word on dividend cuts on UK equities. Back in April, the banks were asked to voluntarily defer dividend payments and Royal Dutch Shell has announced the first cut to its dividend since World War II. Some fund houses predict an overall drop in dividend rates on the FTSE 100 of around 40%. That is huge and bigger than the fallout from the Global Financial Crisis of 2008. To counter this though, some stocks such as BP refuse to cut their dividend, which currently exceeds 10%. These numbers all sound quite worrying, but if we take the Marlborough Multi Cap Income fund as an example of how this plays out in real portfolio terms, the Marlborough fund pre-Corona Virus was yielding 4.67%. As we start to exit the crisis and all companies declare their dividends, the new dividend yield could be between 3.5% – 3.8%, a reduction from what it was, but perhaps not as low as expected. It is always hard to predict dividend yields, because even if a company declares the intent to pay a dividend, until an AGM actually takes place, a dividend could still be shelved or reduced. Many stocks fall into that limbo situation at the moment, whilst other stocks are quoting excessively high yields to encourage investment. The managers we use are not taking up these offers, preferring to deploy capital in stocks which can maintain and build dividends from here over the long term, rather than taking too much of a short-term opportunistic approach.
As the Lockdown starts to ease, I would expect markets to shift focus towards fewer, key issues over the remainder of 2020. The status of the US Dollar as the defensive currency of choice, the US election, China’s recovery, infrastructure spending, climate change targets and the ability of the Eurozone to avoid imploding I suspect will lead market decisions in the months ahead, which leaves us with plenty to ponder.