Log inMarket Update from Jilly Mann
If I think back to the height of the Corona Virus crisis, I recall stating that the most likely outcome would be a swift market recovery back to levels we had seen before the crisis began. If this happened, we would then most likely see a fairly prosperous second half to the year in 2020 as the global economy started making up for lost time. We acknowledged there would be dips along the way, but once we reached the lows in March, logic would suggest a sharp upturn, heading up almost as quick as markets went down.
The subsequent weeks made that theory come under scrutiny as the virus spread quickly, with Governments falling in and out of control of proceedings, and the economic data started to come out. There then arose a growing consensus that the recovery would come, but it would be more selective and less pronounced in optimism.
Up until last week, the data had been as poor as predicted. Company announcements were reporting profit warnings galore, dividends were being cut or deferred, interest rates were being cut and economic barometers were all flashing warning signs. That was until the US announced their unemployment figures last week. These took virtually everyone, except Donald Trump perhaps, by surprise, as the US unemployment figures were much better than expected. Jobs rose by 3 million resulting in the biggest forecast error in history (economists were predicting a 7 million drop). Even more bizarre, was the sectors in which those new jobs arose. Healthcare is no surprise admittedly, but hotels and catering sectors were. It seems that as fast as the US was to cut jobs, they re-hired at a quicker rate.
This news sent markets into an upward trend last week, this was in spite of there being no really significant news on either virus figures falling or a vaccine being found. European equities also rallied last week as a result of further stimulus measures led by Angela Merkel. Each country reports virus figures slightly differently and so it is hard to compare like for like sometimes, but Germany’s virus statistics are some of the most surprising in Europe. If we consider that Germany is a largely landlocked country on three sides and migration has been a major European headache in recent times, one could easily assume that the spread of Covid 19 would have had a much greater impact than it seemingly has done. The German healthcare system may well be better than the UK’s, but even so Germany seems to have this virus well under control. They have recently experienced a mini second wave where their ‘R’ number has risen above 1 as Lockdown ended, but the number has already fallen again to closer to zero. This is a pattern we have seen in Asia as well, again another highly populated region where one could expect a virus to spread faster, but for now it seems to be under control. What happens later in the year as temperatures fall and the flu season arrives, we don’t know, but there are more positive signs than negative for many parts of the globe who have already borne the brunt of Corona virus in the very near term.
Looking to the US, some pollsters now have Joe Biden leading Donald Trump in the race for the White House, but there remain so many unknowns over there. With regard to the virus, in itself, this may not have too great an impact on Donald Trump’s campaign. The states where the virus has hit hard are Democratic areas which are unlikely to vote for Trump anyway and the states where the virus was relatively mild, were largely Republican and so are fully behind Donald Trump’s stance on getting America back to work. In essence, a politically neutral virus for both campaigns. That said New York remains a ghost city and with workers in financial districts unwilling to return to base until the virus is under control everywhere, there therefore remains a knock-on threat to the economy.
If the US economy does rally further from here then that is a positive for Trump, as he has always relied on the strength of the US economy to pull him through, but the race riots are a major unknown. These riots could significantly distort the spread of the virus with so many people in such close proximity to one another and if sentiment continues as it is at present, it will need something quite statesmanlike from Trump to stabilise matters. The virus is not yet under control in the US, infection rates are falling more slower there than anywhere in the world and the country remains in a state of flux.
From our perspective the rallies in US and European equities are welcome in the sense that other markets have followed suit so far, but the rallies don’t feel like they are built on solid foundations.
Concerns over the longer-term prospects for Europe remain. Messrs Merkel and Macron seem to have a plan, but it still needs to be agreed by all member states and that is by no means a given. There always was scope in European stocks for further rises, but until all European states have agreed to the new proposals, there remains a real threat to the concept of closer fiscal union with the likes of Italy and Spain still not feeling that the proposals go far enough, especially with the prospect of deep recession a very real near term threat.
The US market has in its favour that it is largely comprised of sectors which could still stand up in the face of recession. Healthcare and technology as examples. There is less retail in the US market than perhaps is found across Europe and energy stocks are a much smaller proportion of the overall market as well. In a deep recession, retail, energy and financial stocks are likely to be hit the hardest. From that perspective, the US longer term looks attractive and we maintain our view that when we feel the natural resources trade has run its course, the most likely next step for that allocation will be technology and the US. The S&P 500 has held up remarkably well year to date, but it feels more of a phenomenon than a rational outcome. It seems like we are in a market where traditional measures for buying or selling stocks such as the price you pay, don’t matter as much as they once did. We still don’t want to fully participate in the US markets right now, as there is an element of buying whatever someone thinks will still be here in 12-24 months’ time at any price. That can hold true for a period, but at some point, that will unravel and nothing is really protected fully from a recession. We continue to watch the US and technology, we have exposure through our global funds, but for now struggle to tally up the economic data with the Covid data which would give us comfort to take a bigger position.
Interestingly, it has just been announced that the UK has completed 2 months of generating power without using coal. Renewable sources such as wind and solar have helped produce enough power to keep us going through Lockdown. This is the longest time period recorded without relying on coal and marks a further milestone for renewables in 2020. The Liontrust Sustainable Future Global Growth fund benefits from this trend, but interestingly, there has been increased clamour over the last week for Government to spend their way out of the crisis. Four leading economic thinktanks have all joined forces to support increased spending and borrowing to avert a fully-fledged depression developing, rather than merely a recession and have called for an end to thoughts of an austerity policy post Covid.
If we recall what happened post Global Financial Crisis in 2008/09, there was a shift to austerity and restrictions on public spending. The nature of the virus has been so sharp that Government has had to throw so much money at the problem, a natural reaction would be to raise taxes and cut spending back again. This time though it feels like the recession which we all know is coming, will be offset initially by more Government spending. If that is the case and we continue to borrow our way out of this to create jobs which are lost elsewhere, one could expect significant infrastructure and healthcare spending. If that happens then industrialisation will aid commodity prices in the near term and funds such as the Gravis UK Infrastructure Income fund will be beneficiaries through their exposure to healthcare and public infrastructure projects.
It would be easy to get carried away by the hype of the markets over the last week, but we need to be looking a little further ahead and identifying those areas which we think could benefit longer term from Government policy. This is a strategy we could easily see being rolled out in the US and is underway in Asia and Japan already.
Asia has been largely overshadowed by events in the US and Europe in recent days, but China and the Asian region continue to set the blueprint for a post lockdown world. In terms of China, import and export data has been mixed over the last week, perhaps not surprisingly, but this does support the view that we need to be exposed to the Chinese domestic market more than maybe it’s international role in the global economy for the time being. With that in mind we have broadened our exposure to include the Baillie Gifford China fund which has a much more technological bias than First State Greater China. The presence of both funds gives us a defensive ballast as well as some growth momentum as the economy continues to recover. We don’t expect US/Chinese tensions to disappear any time soon, in fact nor do we see North Korean tensions abating as they continue to break ties with South Korea thus extending the Korean War which has never officially ended. We have been living with these conditions for a few years now and we need to be mindful of how these may be used as political pawns ahead of the US elections, but overall, domestic Asia feels like a relatively stable place to be investing.
Our emerging market exposure is heavily weighted towards Asia and we have very little in the way of exposure to Latin America which is really struggling to contain the virus. Brazil and President Bolsonaro seem to be out of control with no purse to spend on stemming the tide. The financial strength of much of Latin America is tenuous in times of crisis and we could see similar issues across Africa and the Middle East should this virus take hold there and so we remain very choosy about where we want to invest at the moment, either for equity or fixed income.
With momentum globally now supportive of a short, sharp recovery, a positive second half to 2020 and a worry about the immediate impact of recession deferred to 2021, we have taken the opportunity to marginally increase our equity exposure in lieu of fixed income. I wouldn’t envisage this being a long-term position, but if bonds are traditionally seen as a low risk, reasonable return asset, some bonds presently represent higher risk, low return assets. Most of our bond funds can withstand these conditions and still return at least the 4% per annum we would hope for from them, but as markets have seemingly rallied, we have seen Government bonds (Gilts, Treasuries) diminish in value, so despite the recession, it isn’t a threat of defaults which afflict lower grade bonds, more a threat of reduced valuations in better quality assets and the need for selectivity over assets such as emerging market bonds, which offer a good return, but at too great a risk level whilst the corona virus wreaks havoc on their economies.
In lieu of bonds, we have increased our exposure to global equity, specifically recovery assets. Much of our portfolios at the moment comprise quality, growth assets, whereas before the crisis we were heavily weighted towards value assets, i.e. those whose share prices remain markedly undervalued against the wider market. We chose not to buy straight back into these assets post Covid as we expected a mass market rally, which is what happened, but we have finally started to see value stocks turn and outperform some growth stocks. Our portfolios comprise very little in the way of mega cap UK or US blue chip companies at the moment, and we have preferred to be much more selective in what we have bought into, but we do now see an opportunity to add some of these larger companies into the strategies again. The Global Recovery fund allows us exposure to the UK, US, Europe and Emerging World, so we are able to complement our existing funds in stocks which will survive Covid and a subsequent recession, but which have the opportunity to return significant growth to client portfolios.
We are in no doubt that a recession is on its way, but that doesn’t necessarily equate to falling stock markets. We saw this post 2008/09 where the world faced a protracted recession, but stock markets rallied for quite some time in spite of austerity. The key to investing through the recovery was to adapt to news and be prepared to be bold when the need arose. The post Covid 19 recovery will be different due to the speed of the fall and subsequent recovery (so far at least), but with an appetite seemingly towards rebuilding some form of normality, there does seem enough market optimism from Central Bank and Government policy for infrastructure spending and the sourcing of alternative employment for individuals displaced from their previous roles by the virus to support the market keeping on track through 2020.
2021 may well be different and continuing to be selective and calm during the up days as well as the inevitable down days will be important to ride out this crisis. As has been quoted by all market commentators in the past few weeks, the Covid 19 market crisis is unique so far. There are similarities we can draw to past events, but the current speed of events is unprecedented. We shall continue to keep you abreast of news as best we can, but please keep in mind that after every mini surge in the market, there is inevitably a period of retrenchment. What the market gaveth yesterday, it can just as easily taketh away tomorrow, however, over the long term we remain confident that the areas we are invested into are resilient and positioned to benefit from a recovery through 2020.