The backdrop to the remaining months of 2020 are truly unprecedented in modern times. The medical world seems more divided than ever on what is the appropriate response to the Covid pandemic. Certainly, at the time of writing the new case numbers are alarming but more crucially the new case/fatality ratio is falling and, whilst this doesn’t seem to get as much media coverage as pubs shutting at 10pm, it is infinitely more important. The global economic fallout to the virus continues unabated but hopes of vaccines, as well as governments across the world reluctance to go for total lockdowns and the new case/fatality ratio continue to offer sufficient encouragement for many market participants to remain broadly optimistic.
What’s really driving markets?
It is worth repeating that the biggest driver of risk asset price movements is Central Bank monetary policy. Eye watering amounts of money printing and respective bank commitments to keep interest rates low indefinitely, combined with massive global government spending are ultimately the equity market’s saviour. What makes this market backdrop, which has been going on since October 2018 unprecedented, is that investors have worked out that the Central Banks and Governments effectively have no option but to carry on down the same path. Some event or crisis might eventually lead to a change of course, but after the sharp drawdown in equity valuations in February/ March the market does not think Covid-19 is it.
And the winner is…
We have an upcoming US election where neither side has said they will necessarily accept the result, nor during the first presidential debate did they take the opportunity when asked to appeal for a nonviolent response from their respective supporters. If the outcome is contested then we will have to endure several months of High Court wrangling, the unedifying spectacle of mudslinging and claim and counter claim until ultimately somebody has to be declared the winner. The timing of this could potentially not be worse for an America so deeply divided on multiple issues, not least of which being the response to the pandemic. This outcome could be unsettling in the short term for markets but eventually America will get back to business with either Trump or Biden at the helm, or if fate intervenes potentially their respective Vice Presidents.
The Global Economy
It is clear now that the ‘V’ shaped economic recovery is not happening in large parts of Europe (including the UK) and the US, and this is in stark contrast to many parts of Asia and especially China. As is often quoted however, the stock market is not the economy, well at least not in the short term anyway. China remains one of the best performing equity markets in 2020 but, whilst quite a way behind the US, is the best performing developed equity market thanks largely to its large tech firms. These have dragged much of the American market with them, as firstly they were favoured for their attributes as growth stocks but then, as it was realised that the pandemic could be with us for some time, they became favourites as defensive stocks. So, they really have been in the investing sweet spot and are still seen as the stocks to principally benefit from the working from home culture. Stock and bond markets often overshoot on news that in reality has relatively short-term effects but this time it really is different. There are however more longer-term market implications with the new working and living patterns than Netflix subscription numbers and speed of Amazon deliveries, though these are the kind of stories which garner much of the media coverage.
Not all stock markets are created equally
Whilst the US market has benefited from the kind of stocks which make up a large part of the index, at the other end of the scale is the much-maligned UK. The only developed market to be performing worse than the UK is the Spanish one and they have had a particularly difficult time with the pandemic, as well as suffering high unemployment and a collapse of their essential tourist industry. The problem for the UK is that our flagship index, the FTSE 100, is largely populated with large oil companies, mining and bank stocks which is a basket of stocks you haven’t wanted to own and to a large extent it hasn’t even mattered which individual stocks in the sector you have held. When the oil price for future delivery went briefly negative it was not ideal that two of the biggest UK stocks are BP and Shell, there was nowhere to hide. Whilst the short-term debate was about the lack of available storage for oil and a spat between Russia and Saudi Arabia about production, it inevitably leads to the far more wide ranging question of – what is the future for oil?
The UK has traditionally been a market for bigger than average dividend payments from many of the sectors and unfortunately Covid has forced many other companies to cut these highly prised dividends. Again, the question for investors, fund managers and the companies themselves is how long this situation will last, and the answer is that nobody knows for sure but there is a lot of bad news now priced into the UK stock market. On top of any Covid issues, we also have the Brexit saga to contend with and no matter where an individual stands on the argument of membership of the EU, the effects of the vote so far have been largely negative but that negativity is very much based on the ongoing uncertainty. Whilst this is obviously big news for the UK we doubt that any outcome will have a significant impact on either global trade or global markets.
Uncertainty is the enemy of risk assets
It’s easy to feel daunted by numerous events and uncertainties which could destabilise markets. At the same time, it is becoming quite a skill to avoid the endless stream of misery being beamed into our homes or via our phones. Whilst we expect the next few weeks and months to be unsettling at times, if we fast forward to say spring of the next year the world could be looking very different. Hopefully by then we will have a President of the US who is accepted by the majority of Americans, Brexit will have had some kind of resolution and furthermore we should have by then made breakthroughs on multiple fronts on the pandemic.
The key investment strategy is to be diversified as we inevitably find new winners and losers, which is why we spend so much time trying to make sure our portfolios/funds are just that. Nobody can predict the future but it’s never been more important to have a mixture of geographies, different kinds of funds and different asset classes from gold to equities, bonds and infrastructure. As the world is changing so rapidly it’s also necessary to hold multiple managers in each of the respective sectors, as inevitably different outcomes will be clearer to different managers at different times.
No Change
We went into 2020 with our investments more defensively positioned than previously and that wasn’t any insight to the impending pandemic but rather a reflection on our view that markets looked expensive and had already come a long way.
In August we made changes to our portfolios/funds which reflected the market conditions we anticipated in Q4 2020. Since then the global market situation has become even more complicated and rather opaque. For this reason, we find ourselves in the rare position of not making any changes to our portfolios/funds at this time. We had a similar period back in 2009, when we didn’t feel it was possible to have sufficient conviction in any changes adding value, and like then we feel our current investment mix is the right one for the conditions.
It always needs to be remembered that uncertainty and volatility lead to investment opportunities, though as human beings it doesn’t necessarily always feel comfortable at the time.
This communication is designed for Professional Financial Advisers only and is not approved for direct marketing with individual clients.
Past Performance is no guarantee of future performance. The value of an investment and the income from it can fall as well as rise and investors may get back less than they invested. Risk factors should be taken into account and understood including (but not limited to) currency movements, market risk, liquidity risk, concentration risk, lack of certainty risk, inflation risk, performance risk, local market risk and credit risk.
IAM 307.10.20
