Market Update From Jilly Mann
It has been a few weeks since our last update and whilst there has been plenty of rhetoric, the impact on markets has been much more subdued.
In this update, we will cover:
- The consequences of a successful Covid 19 vaccine for markets
- The Federal Reserve’s approach to inflation and Yield Curve Control
- The US Presidential election and what a Biden victory could mean for markets
- US/China relations
- Property fund restrictions
The consequences of a successful Covid 19 vaccine for markets
The disconnect between rising Covid diagnoses and stock markets has continued over the last month. That is not to say if a global lockdown were to take effect again that markets wouldn’t fall as a result of yet further economic gloom, but daily reports of cases in specific countries, notably across Europe and India where the numbers continue to head upwards, are not inevitably causing stock markets to fall on such announcements.
For the month of August to date, most major global stock markets are in positive territory despite what has seemed like a barrage of negative economic data and announcements. Incidentally, one of the markets to not be positive month to date is the traditional safe haven and inflation hedge which is Gold. The price of Gold has come down slightly from its record high of over $2,000 per ounce as it stands today.
There is a school of thought to say that we are firmly in a bull market and the trip hazards we are experiencing are simply interruptions on a positive trajectory. Much of this positivity is fuelled by optimism that we are inching closer to a successful vaccine being found. The signs so far are encouraging that we are in a race to find the winner rather than stumbling to find an answer. The moral debate will then rage as to when such a vaccine will be safe to use, but the mere existence of a vaccine that can be proven to work on a high proportion of cases should be enough to stave off the threat of a global recession, in the short term at least. This is positive for equities which can throw off some of the restrictions imposed on trade by Covid and is supportive of the bull run theory.
The diminishing threat of a recession though could spell bad news for bonds and fixed income. The concern would be that Central Banks will be keen to raise interest rates in a stronger economic environment, which will negatively impact the value of bonds. At present we are quite cautious on the type of bond funds we own, not wishing to overweight towards Government Bonds or high-grade credit (i.e. better-quality bonds). So far the Janus Henderson Fixed Income Monthly Interest fund as an example, has returned over 20% since the lows in the UK of mid-March. If we do see tightening in the bond market, we remain confident that the funds we have chosen will continue to deliver a steady return, but monitoring which elements of the bond market could be affected is something we are keeping a close eye on.
The Federal Reserve’s approach to inflation and Yield Curve Control
This brings us on to the USA’s Federal Reserve’s latest announcement, whereby what they didn’t say spooked markets, albeit for just a day, far more than what they did say. The Federal Reserve (Fed) have explained that they felt that implementing yield curve control would only bring modest benefits in the current environment and this isn’t something they are looking to do in the short term. The market had previously priced in the assumption that the Fed would implement yield curve control imminently to further bolster sentiment. That they haven’t done so caused a day of worry on the market, which has subsequently abated rather. Yield curve control is a rather complicated concept, but in essence it would provide another tool for the Fed to effectively peg interest rates up to a certain date in the future. Between now and then the Fed would be the buyer of any assets maturing, so is in effect a further way for the US to pump money into the economy whilst providing some security against rising interest rates in the future. A consequence of yield curve control would also be a control on inflation, which could be allowed to run higher without controls in place and this is feared by the market. The case for or against this action isn’t black or white and the Fed maintains the option to step in and buy assets in the future, they just didn’t want to commit to that now. If a successful vaccine is found then they may continue to veer away from yield curve control, but if such actions were deemed necessary in the future, it would be hard to see them not pursue the idea further.
All that said, the US equity markets have shaken off this news with both the Nasdaq and S&P 500 indices continuing to trade at record highs.
The US Presidential election and what a Biden victory could mean for markets
Remaining with the US, the race for the White House has progressed further in recent weeks with Joe Biden announcing his running mate, Kamala Harris. The rhetoric around Joe Biden’s campaign has appeared largely positive compared to a more subdued Trump campaign thus far, but it is too early to believe that Biden really is far ahead in the polls. If Biden finally wins the Presidential campaign, this may not be such good news for markets. With a Trump administration, markets know what to expect, i.e. more aggressive foreign policy and protectionism towards the domestic market at all costs. With Biden, foreign policy, particularly towards China, would likely be less aggressive on a diplomatic scale, but the anti-China theme is hugely popular in the US and unites both Republicans and Democrats, so one could reasonably expect Biden to piggyback some of the steps Donald Trump has taken so far against the Chinese, but perhaps with a more tolerant approach en route.
Biden could also be good news for US infrastructure and industrial projects, but he is likely to mean bad news for the technology sector, where he is expected to take a much more aggressive fiscal policy stance on the FAANG stocks (Facebook, Amazon, Apple, Netflix, Google). The S&P 500 has reached a record high in 2020, but overall is only up just over 4.5% year to date. The NASDAQ index, which is primarily a composite technology index, is up over 25% over the same time period. Technology is dragging the US stock market upwards and has become the defensive sector of this economic cycle. With US Covid cases rising and the economic signs looking gloomy, it is a potentially dangerous move for any President to then attack the one area of the market which continues to outperform, but that is a very real threat under a Biden administration. The Baillie Gifford American fund which has a high allocation to technology is up just shy of 6% since we bought it in mid-July, and alongside the Threadneedle UK Smaller Companies fund, it has been one of our best performers. We think the technology sector has further to run in spite of the record highs, and now feels like a time to buy quality not the cheapest assets possible.
US/China relations continue to deteriorate, but this increasingly feels like a bigger issue for global diplomacy than investment markets.
Since the outbreak of Covid, Chinese growth recovery has led the global recovery. Even if President Trump continues to bring sanctions and impose further tariffs to block Chinese companies such as Huawei, China can still continue to grow. China’s net exports are now reported to contribute nothing to Chinese GDP (i.e. their exports completely offset their imports) and so China is a standalone economy, the genie is out of the lamp in terms of trying to hurt China with tariffs, we need them more than they need us seemingly. The US crusade against China is unlikely to end any time soon, but if the US handle this ineptly, they themselves are likely to be the one damaging global growth. According to Bloomberg, steel stocks are experiencing their strongest rally since 2015 with copper at its highest price in 2 years, bolstered by Chinese demand. US industry benefits from an upsurge in industrial activity, just as US majors have derived much of their profit from sales to China in recent years, be that from retail, autos or technology. Nobody expects tensions to thaw, but relations are so taut now that a step too far by the US could do far more damage domestically than to its foreign adversary.
The US and China have rather dominated proceedings of late, but a word on the UK stock market. We sold out of the Marlborough Multi Cap Income fund last month, retaining the Threadneedle UK Smaller Companies fund as our main UK equity fundholding. Since we made the change, the Threadneedle fund has added a further 5.7% in growth, whereas the Marlborough fund has returned 1.5% with the FTSE 100 returning a negative 3.75%. There are returns to be found across the UK, Europe, the US and the Emerging world, but it is very selective as these figures demonstrate.
Property fund restrictions
Moving away from equities to an update on the Property sector. As you may recall, UK commercial property funds have been unable to trade since March this year due to relatively new guidance surrounding “material uncertainty”. Material uncertainty has affected the whole of the UK Property market with valuers being unable to fairly value properties during lockdown. The good news is that 79% of the BMO UK Property fund (the fund we use for our client portfolios) has already been released from this material uncertainty clause and the remaining assets are due to be valued in the coming weeks. Assuming all is well, BMO will take steps to make the fund tradable again to all investors. Interestingly, despite both the Regulator and economic commentators raising questions over the future viability of UK Commercial Property as an investment asset class due to liquidity and post Covid void concerns, the BMO UK Property has achieved its lowest ever void rate, at sub 3%. The industry average is around 8%, but BMO were able to negotiate two new rent reviews during lockdown and are quietly confident with the work they have done to ringfence the assets and protect them from the worst of the UK economic downturn. The headlines never shout about these things. Given their relatively strong position, they may well be approached by vendors needing quick sales, but they most certainly are not looking for distressed assets to buy on the cheap, if they have to pay a decent price for a quality asset to yield 7-8% per annum, they will continue to do that to maintain a quality portfolio. This property update has been very encouraging and is an area where we may find opportunities in the coming months, especially if we do see any threats to the bond market materialise.
Another area we are keeping under review is our value biased allocation. Across portfolios we are overweight growth funds at the moment believing that there is a fair price to pay for returns in these markets rather than the heavily beaten up stocks which are cheaper, but much more dependent on a string of events taking place to make them rise. The latter being representative of a value bias. We have hedged the portfolios with some value assets in recent months, simply because if we do exit a recession sooner rather than later, one could feasibly see a sharp reversal in the banking sector and other such hubs of value assets, whose value may rise rapidly amidst renewed market confidence. It is too early to say whether growth, value or indeed a mixture of the two will be the right approach for the remainder of 2020, so for now we have our toe dipped into the value world, but we have alternative strategies in reserve, should we see the environment for value to prosper return. Conversely, if we see markets turn negative for any period, our “Plan B” strategies are in place ready to be implemented and that will continue to be the case as the world works through this virus and the economic fallout.
We will of course update you again as events develop and in the meantime we hope that you all remain safe from the virus, which seems to surround us in this region quite heavily at the moment. Incidentally, we have provided antibody testing for our team in the office this week and thankfully, so far, all have been negative. The challenge now is to stay that way.