The Kingswood Investment Podcast: Recent Episodes
Kingswood Group
The equity market rally paused last week with global equities little changed in local currency terms. Even so, this still leaves markets up a hefty 10% so far this month with UK equities gaining as much as 14%.
The November rally started with the US election results but gathered momentum with the recent very encouraging vaccine news. This continued today with the AstraZeneca/Oxford vaccine proving to be up to 90% effective in preventing Covid infections. This is slightly below the 95% efficacy of the Pfizer and Moderna vaccines already reported but this one has the advantage of not needing to be stored at ultra-cold temperatures. One or more of these vaccines now looks very likely to start being rolled out within a few weeks.
Of course, these vaccines will do little to halt the current surge in infections. Cases may now be starting to moderate in the UK and some countries in Europe but the trend remains sharply upwards in the US. The damage lockdowns are doing to the recovery was highlighted today with the news that business confidence in the UK and Europe fell back into recessionary territory in November.
Markets, however, are likely to continue to look through this weakness to the prospect of a strong global recovery next year. While equities may have little additional upside near term, they should see further significant gains next year. Their current high valuations should be supported by the very low level of interest rates, leaving a rebound in earnings to drive markets higher.
Prospective returns over the coming year look markedly higher for equities than for bonds, where return prospects are very limited. As for the downside risks for equities, they appear much reduced with the recent vaccine news and central banks making it clear they are still intent on doing all they can to support growth.
Both factors mean we have taken the decision to increase our equity exposure. While our portfolios already have significant allocations to equities and have benefited from the rally in recent months, we are now moving our allocations into line with the levels we would expect to hold over the long term.
Our new equity allocations will be focused on the ‘value’ areas of the market. The last few weeks have seen a significant rotation out of expensive high ‘growth’ sectors such as technology into cheaper and more cyclical areas such as financials, materials and industrials. Similarly, countries and regions, such as the UK which look particularly cheap, have fared well just recently.
We think this rotation has further to run and will be adding to our UK exposure. This does not mean we have suddenly become converts to Boris’s rose-tinted post-Brexit view of the UK’s economic prospects. Instead, this more favourable backdrop for cheap markets is likely to favour the UK.
We will also be adding to US equities. Again, this does not represent a change in our longstanding caution on the US market overall due to its high valuation. Rather, we will be investing in the cheaper areas of the US which have significant catch-up potential.
We are also making a change to our Asia ex Japan equity holdings. We will be focusing some of this exposure on China which we believe deserves a specific allocation due to the strong performance of late of that economy and the sheer size of the Chinese equity market.
On the fixed income side, we will be reducing our allocation to short maturity high quality UK corporate bonds, where return prospects look particularly limited. We are also taking the opportunity to add an allocation to inflation-linked bonds in our lower risk, fixed income heavy, portfolios. These have little protection against a rise in inflation unlike our higher risk portfolios, which are protected through their equity holdings.
Global equities bounced close to 7% last week, more than reversing their 5% decline the previous week. They opened up another 1.5% this morning and were testing their all-time highs even before the positive vaccine news gave them another 3-4% boost.
So why the euphoria on the back of the US election results? After all, Biden’s victory was not exactly a big surprise – he was the firm favourite going into the election.
First and most important: markets like certainty. The worst case scenario of a close result with weeks of uncertainty seems to have been avoided. Trump may well continue to dispute the result but his legal challenges look very unlikely to succeed with Biden’s margin of victory large enough not to be overturned in any re-counts.
The one thing a Biden Presidency can surely be guaranteed to bring is more stability, particularly in foreign policy. This is all the more the case now as the prospect is for a divided government which will severely limit his ability to implement the more radical elements of his policy program.
Indeed, the real surprise was not Biden’s victory but that the clean sweep by the Democrats, which markets had increasingly been pricing in, failed to materialise. The Democrat majority in the House of Representatives was reduced and the Republicans look likely to retain control of the Senate. The latter will only be confirmed on 5 January when there is a re-run of the election of Georgia’s two senators.
Biden’s policies always contained a mixture of the good and the bad as far as markets were concerned. The good included his plans for a major fiscal stimulus while the bad included higher taxes on corporations and more regulation. Action in both areas should now be limited. On the fiscal front, a stimulus package will probably still be agreed in the next couple of months but will be half the size it would have been with a clean sweep.
At the end of the day as ever, market prospects from here will be driven by the economic outlook. While the US recovery has been stronger than expected, the rapid rise in infections now being seen mean it still faces significant challenges. The Biden Government’s Covid policy can only be an improvement but Biden is not inaugurated until 20 January and a big fiscal boost is no longer on the cards.
Today’s news that Pfizer and BioNTEch’s vaccine is effective in preventing 90% of people from contracting Covid-19 is clearly a major step forward but it is not a silver bullet. A mass roll-out of vaccines was always going to take time and logistical issues can only be increased by the need to store the vaccine at ultra-cold temperatures. It is also far from clear what proportion of the population will be willing to be vaccinated and how long immunity will last.
Back here in the UK, the authorities took action last week to limit the hit to the economy from the new lockdown. Amongst other measures, the furlough scheme was extended to March at an estimated cost of around £6bn per month and the Bank of England boosted its quantitative easing program by £150bn to £895bn. This will allow it to remain a major buyer of gilts through next year.
Even so, the Bank has revised down its growth forecasts and is now forecasting the UK economy to contract again in the fourth quarter. The Eurozone economy also faces a double-dip recession with lockdowns in place in a number of countries. The near-term economic outlook therefore remains challenging in the UK, Europe and the US. As yet, it only seems to be China which has a secure recovery under its belt.
Today’s vaccine news does make it all the more likely that economies outside China resume their recovery in the new year as vaccines start to be rolled out. This in turn should set the scene for further gains in equities. Near term, however, with equities currently now up as much as 12% in little more than a week and valuations at twenty year highs, the good news seems very much priced in.
Global equities took a tumble last week, losing 5.0% in local currency terms. This left markets down some 7% from their early September high but still leaves them up some 40% from their March low.
The reason for the sell-off is not hard to fathom, namely the surge in infections in the UK and Europe and the new lockdowns announced both here and in countries such as France and Germany.
Lockdown 2.0 is not as severe as its predecessor but will still deal a significant blow to economic activity. The Eurozone and the US last week may both have announced record growth in the third quarter, but GDP remained a sizeable 4.3% and 3.5% respectively down on the end of last year. The latest lockdowns now threaten a renewed decline in Europe in the fourth quarter.
The UK hasn’t released Q3 numbers as yet, but as of August, GDP was as much as 9.0% below its end-2019 level. It has been one of the economies worst hit by Covid and remains one of the most vulnerable. Even though Rishi Sunak has now reinstated the more generous furlough scheme, the lockdown risks reducing GDP by a hefty 5% or so in the fourth quarter.
The US also looks likely to see growth suffer over coming months with infections climbing sharply and the government response chaotic. Only in China is Covid already beginning to seem like a distant nightmare with GDP up 4.1% this year. This divergence has been reflected in the marked outperformance of the Chinese stock market year-to-date, which continued last week with it down only a modest 0.5%.
While the next couple of months could well see further market weakness, we do not expect anything like a re-run of the sell-off earlier in the year. The lockdowns are less severe, the hit to GDP should be much smaller and we are rather closer to seeing light at the end of the tunnel. Much more extensive testing, better treatments and vaccine roll-outs should all lead to the picture steadily improving through next year and in time provide the rationale for further gains in equities.
In the meantime, one source of support is coming from earnings. We are now over half-way through the Q3 reporting season in the US and earnings are coming in considerably better than expected. The tech giants reported last week and generally beat expectations (not that it did their share prices much good) as did the banks earlier in the month. S&P 500 earnings now look likely to fall some 10% rather than 20% as was the expectation at the start of reporting.
Still, markets near term have not only to contend with Covid but also the US elections. We will keep our comments brief today. So much has already been written on the subject and, with the result still uncertain, it makes sense to wait until the dust has settled before pontificating any further at any length. It should also not be forgotten at times such as these that the importance of the US election in driving markets is often exaggerated. More important generally than which party wins the election is the state of the business cycle, Fed policy and also this time, of course, Covid.
What can be said with any confidence is limited. Biden remains the front runner but his victory is far from assured. The worst outcome for markets would be a close and contested vote which might not see the victor announced for weeks. As for the best outcome, other than a clear victory by either candidate, it is far from clear. Biden’s policies are a very mixed bag and the ability of Trump or Biden to implement their policies will depend on winning control of Congress.
We will be sending out a post-election update on Wednesday by which time we may, or may not, be able to shed some further light on these matters.
Last week was a relatively quiet one for markets, with global equities ending 0.4% lower in local currency terms. Coming weeks, however, look set to be a rather more lively affair with several key areas of uncertainty being resolved one way or the other, or not.
The first major uncertainty and area of concern relates to the second wave of infections and social distancing restrictions now being introduced in the UK and much of Europe. This poses a threat to the economic recovery which was already showing signs of slowing. Indeed, business confidence retreated in October with the services sector driving the decline.
Here in the UK, the Chancellor has been forced into a major expansion of the job support scheme which takes over from the furlough scheme in November. There was also more help announced for the self-employed and businesses affected by Tier 2 restrictions. In total, these measures could cost a sizeable £15bn or so and the budget deficit this year now looks likely to end up a whopping £350bn or 17% of GDP - or possibly even more.
With infections still continuing to climb, the effectiveness of the new restrictions far from clear and the timing of any vaccine roll-out still up in the air, the virus clearly remains a wild-card for markets.
So too do the US elections on 3 November. Biden continues to have a significant 9% lead in the polls and the betting markets currently give him a two in three chance of victory. Still, it remains far from a done deal with the battle in some of the key swing states tight. Moreover, control of the Senate, which will be critical in determining to what extent Biden can implement his agenda, is even more of a close call.
The market’s preferred outcome seems to be for a clean sweep by the Democrats which will allow the implementation of a sizeable fiscal stimulus. If by contrast, there were split control of the Presidency and Congress, this would effectively lead to a continuation of the status quo with divided government a major constraint on new policies. Worst of all, however, would be a close and contested result with possibly weeks of rancour and confusion in prospect.
Then there is Brexit, where the prognosis is as unclear as ever. Talks were called off the weekend before last but are now back on. The only thing certain is that crunch time is approaching rapidly.
One final source of uncertainty relates to valuations which have been the main factor driving this year’s violent swing in equity markets. The 2-year forward-looking price-earnings ratio for global equities was 17x back in February, collapsed to 10x at the market low in March, only to rebound to 19x now - the highest level in twenty years.
This would set alarm bells ringing if interest rates were not at unprecedentedly low levels and equities did not still look reasonably valued against bonds. While we believe current valuations should be sustainable with no hike in rates likely any time soon, they leave little room for error.
All this leaves the markets facing an uncertain time over the next couple of months. In the new year, however, equities should have scope for further gains if, as seems likely, vaccines start to be rolled out, bringing the prospect of a slow return to quasi-normality.
Global equities overall ended last week little changed but this concealed significant differences in performance between regions. Chinese stocks rose 2.6% in sterling terms while the US gained 0.7% and the UK declined 1.5%. This continues a trend very much in evidence already this year – China is up 25% year-to-date while the US up 12% and the UK is down 19%.
This dramatic divergence is not hard to explain. The Chinese economy has suffered much less from the pandemic than most others. This was confirmed this morning with the latest crop of economic releases which showed Chinese activity almost back to normal. GDP was up 4.9% in Q3 on a year earlier – by contrast, UK GDP in August was still down 9.2% on the previous year.
As for the US economy, it hasn’t fared half as well as China but hasn’t been hit half as badly as the UK. Despite the failure to agree a new fiscal stimulus, recent data show the US recovery continues with retail sales posting a sizeable, and larger than expected, rise in September.
The Q3 results of the big US banks last week backed this up. Their earnings beat expectations, partly because of a surge in trading revenues but also because of reduced loan loss charges as the economy hasn’t performed as badly as feared.
The US elections remain a major focus. The markets seem to have taken a liking to the idea of a Biden victory and possible clean sweep by the Democrats because it would lead to a sizeable fiscal boost. However, this result is still not a done deal with the betting odds of a Biden victory narrowing back down to 60% from 65% a week ago. The final Presidential ‘debate’ on Thursday may be Trump’s last chance to narrow the polls which still favour Biden.
Back closer to home, the economic picture for Europe looks rather grimmer. The spike in infections is leading to a wave of new social distancing/localised lockdown measures and there is now talk that this could even trigger a double-dip recession.
Here in the UK, we not only have to contend with new lockdown measures but also Brexit. Last week had been billed as critical with the EU Summit and Boris’s 15 October deadline for the guts of a deal to be agreed. However, somewhat unsurprisingly, a week later and we are not much the wiser.
Boris has now officially broken off trade talks…unless the EU comes back with concessions. This still clearly leaves the door open for a compromise to be reached despite the bluster to the contrary. That certainly appears to be the way the currency markets are reading it.
The pound in the past has been very sensitive to the changing odds of a Deal or No-Deal but last week it hardly moved. If we do end up with No-Deal, sterling will very likely fall although maybe by not that much as the difference between the two options now on the table – No-Deal or a very minimalist Deal – is not really that large. As regards the continuing underperformance of UK equities, this probably reflects the view that Brexit, whatever form it ends up taking, is the last thing the economic recovery needs right now.
If there is No-Deal, the impact may be more visible in intra-market moves rather than on the market overall. A fall in the pound would provide some protection to the FTSE 100 as around 75% of its revenues come from abroad. These earnings will not be that exposed to the UK economy and be worth rather more in sterling terms. Mid and small cap stocks, by contrast, will be rather more vulnerable. They have a little less than 50% of their earnings coming from overseas and could give back some of their recent outperformance.
All this leaves us continuing to believe that markets are in for a choppy few weeks. They are likely to be buffeted by fast changing news flow on lockdowns, vaccines, the US elections and Brexit.
Last week was a surprisingly good week for equity markets. Global equities gained as much as 3.4% in local currency terms and have now recovered the bulk of their losses in the recent correction.
The latest gains at first sight are puzzling given the shenanigans going on in the White House. Of course, it is possible that markets may simply have taken heart from President Trump bouncing back from Covid, larger than life than ever. But they are not known for their sentimentality.
The explanation is more hard-headed. Far from Trump benefiting from a sympathy vote, his antics have increased Biden’s lead in the polls to close to 10%. The betting markets now give a two in three chance of Biden winning the Presidency.
If there is a clear victory for Biden, this reduces the chances of possibly the worst outcome for the markets – a result which would remain in dispute for a number of weeks after the election. A decisive victory, particularly if it includes the Democrats gaining control of the Senate, would also mean it would be easier for Biden to implement his plans for a sizeable fiscal stimulus package early next year.
The concern recently has been that Congress and the President have failed to agree a package to replace the stimulus measures which expired in July. The position here changed almost daily last week but on balance an agreement still looks unlikely this side of the election. If so, the prospect of a new Democratic Government able to enact an increasingly badly needed fiscal stimulus clearly has its attractions.
Still, one should not forget that Biden’s plans for hikes in corporation tax and the minimum wage and increased regulation are distinctly less market friendly. It still looks very likely the lead up to the election will be a period of volatility for markets.
Back here in the UK, the US has been a distraction from the grim news on infections and lockdowns and the latest downbeat GDP numbers. UK GDP posted a sizeable 2.2% m/m gain in August which in normal times would be cause for celebration. However, the increase was half the size expected and significantly smaller than the gains seen in June and July.
The pace of the recovery has slowed significantly even before renewed social distancing restrictions had started to be imposed. Yet the economy still has a long way to recover with GDP remaining down some 9% from its peak. By comparison, GDP fell around 7% in the Global Financial Crisis.
This gloomy outlook may have some bearing on whether or not we end up with a Brexit deal. The last thing the economy, and indeed the Government, needs is the inevitable disruption that would be caused in the New Year by a No-Deal.
This week will be critical with the Prime Minister adamant that the guts of an agreement need to be sorted out by the EU summit on Thursday. On balance, we believe a minimalist deal will eventually be reached, albeit not by Thursday.
While Brexit and the new lockdown measures will be the centre of attention for the UK this coming week, global markets will be more concerned with the start of the US reporting season for the third quarter. Earnings are forecast to fall a substantial 20% compared with a year ago. However, this is a smaller decline than expected a few weeks ago and the 30% drop seen in the second quarter.
Any further gains in equities over the coming year will very likely need to be driven primarily by earnings gains rather than a further re-rating of valuations. Management guidance will therefore be pored over as closely as ever even if the outlook in reality depends heavily both on the election result and forthcoming vaccine developments.
We warned recently that equity markets were entering choppy waters and last week’s developments can only add to the turbulence.
Equities had started to recover some of their losses in the recent correction but the first of the US Presidential debates and then the news of Trump testing positive for Covid swiftly took centre stage. Equities fell back on Friday only to perk up again this morning.
Biden was widely agreed to have fared better in last week’s debate – not that much debate actually managed to take place. Trump testing positive is more of a wildcard but would also seem to favour Biden. It focuses attention back onto Covid (not Trump’s strong point) and the President’s campaign is now in disarray. Against that, Trump could benefit from a sympathy vote.
Biden has had a consistent lead in the national polls in recent months and is also leading in the key battleground states. He looks considerably better placed than Clinton was four years ago and the betting odds have recently moved significantly in his favour, with his chance of victory now put at 60%.
However, as far as the markets are concerned, the Congressional elections are almost as important as the Presidential election. Currently, the Democrats have a sizeable majority in the House of Representatives but the Republicans have a small majority in the Senate. If as now looks quite possible, the Democrats took the Senate as well as the Presidency, this clean sweep would mean many more of Biden’s policy pledges would be implemented rather than thwarted.
As for the policies themselves, they’re a mixed bag. They include plans to raise the corporate tax rate and minimum wage and for increased regulation – none of which are market friendly. But Biden also plans a sizeable increase in spending on infrastructure, healthcare and education. This would be more positive particularly if it fed into higher growth.
Biden’s approach to foreign policy should also make for less of a roller-coaster ride. Even though US hostility towards China looks certain to continue, his approach is likely to be less impulsive and confrontational than Trump’s.
The impact of last week’s news is complicated by the failure of the federal Government to agree a renewal of the income support measures which expired in July. A deal had become unlikely ahead of the election but, with the fall-out from Covid all too visible once again, this could force a compromise to be reached which would be positive.
One final complication is that this all assumes there is a clear election result. The possibility which is haunting the markets is that the vote is a close-call. The result might then not be established for weeks and Trump may not go quietly with all his talk of electoral fraud due to increased postal votes.
The bottom line is that the US elections have many moving parts and will be a sure source of market volatility over the next month or two. That said, we are not expecting a repeat of anything like the turbulence we saw earlier in the year. At the end of the day, the lesson from history is that Fed policy is generally much more important for markets than Government policy – and the Fed is a centre of stability at the moment with policy firmly on hold.
Equity markets had another choppy week, falling for most of it before recovering some of their losses on Friday and posting further gains this morning.
At their low point last week, global equities were down some 7% from their high in early September. US equities were down close to 10%, hurt by the large weighting to the tech giants which at least initially led the market decline.
The market correction is nothing out of the ordinary with 5-10% declines surprisingly common. Indeed, a set-back was arguably overdue given the size and speed of the market rebound from the low in March. As to the cause for the latest weakness, it is all too obvious – namely the second wave of infections being seen across the UK and much of Europe and the local lockdowns being imposed as a result.
These will inevitably take their toll on the economic recovery which was always set to slow significantly following an initial strong bounce. Indeed, business confidence fell back in September both here and in Europe with the declines led by the consumer-facing service sector. A further drop looks inevitable in October – fuelled no doubt in the UK by the prospect that the latest restrictions could be in place for as long as six months.
The job support package announced by Rishi Sunak did little to boost confidence. Its aim is to limit the surge in unemployment triggered by the end of the furlough scheme in October. However, the scheme is much less generous than the one it replaces as the government doesn’t want to continue subsidising jobs which are no longer viable longer term. A rise in the unemployment rate to 8% or so later this year still looks quite likely.
Aside from Covid, for the UK at least, there is of course another major source of uncertainty – namely Brexit. Another round of trade talks starts this week and we are rapidly reaching crunch time with a deal needing to be largely finalised by the end of October.
Whether we end up with one or not is still far from clear. That said, the prospects for a deal maybe look rather better than they did a couple of weeks ago when the Government was busy tearing up parts of the Withdrawal Agreement. With significant Covid restrictions quite probably still in place in the new year and the Government already under attack for incompetence, it may not wish to take the flack for inflicting yet more chaos onto the economy.
Markets remain unimpressed. UK equities underperformed their global counterparts by a further 2.7% last week, bringing the cumulative underperformance to an impressive 24% so far this year. The UK weighting in the global equity index has now shrunk to all of 4.0%.
It is not only the UK which faces a few weeks of uncertainty. The US elections are on 3 November. We also have the first of three Presidential debates this Tuesday. Joe Biden’s lead looks far from unassailable, a close result could be contentious and control of Congress is also up for grabs.
All said and done, equity markets look set for a choppy few weeks. Further out, however, we remain more positive – not least because the focus should hopefully switch from the roll-out of new lockdowns to the roll-out of a vaccine.
Global equities ended last week on a negative note and were down around 4.5% from their all-time high in early September. This morning, European markets have fallen back a further 3%.
The initial catalyst for the correction was a sharp run-up in the mega cap tech names which had left them looking extended and ripe for some profit taking. The FAANGs are now down over 10% from their highs and the froth looks like it has been blown off. While they may well remain volatile, there is no obvious reason for them to be at the forefront of any further sell-off. The fundamentals behind the tech sector remain strong and valuations are once again looking more reasonable.
However, the correction also clearly had its roots in the sheer scale of the rebound from March with global equities up some 50% from their low. This inevitably left markets vulnerable to a set-back, particularly with valuations at twenty-year highs.
The rebound in turn was in good part a result of the massive policy stimulus. The weakness late last week was triggered by disappointment that the US Fed had not extended its QE program. Even so, the Fed is still buying $120bn of bonds a month and remains a major support for equities. Indeed, it made it clear that it has no intention of raising rates for at least another three years.
The Bank of England also decided to leave policy unchanged last week. However, it kept open the possibility of cutting rates into negative territory next year if it should be necessary. An extension of its QE program later this year also remains quite possible.
All the same, the fact of the matter is that central banks have now spent most of their ammunition. Going forward, changes to fiscal policy will be much more important than any tweaks to monetary policy in shaping the economic recovery. And on this front, the news is not particularly encouraging as the markets may now be appreciating.
The US has failed to agree an extension of the fiscal stimulus measures which expired in July and may now not do before the November elections. As for the UK, Rishi Sunak is still resisting calls to extend the furlough scheme beyond October.
Just as important for markets will of course be Covid-related developments. This morning’s declines are a response to the second wave of infections now being seen in the UK and across much of Europe and fears that renewed social distancing measures/localised lockdowns could disrupt the economic recovery.
While the latest wave of infections is clearly a major cause for concern near term, it shouldn’t be forgotten that the longer term outlook regarding Covid is not all bad. Several late stage vaccine trials are now underway and a vaccine could quite possibly become available within a few months. Some countries, most notably China, also seem to have avoided a major secondary spike despite the reopening of their economies.
In short, the outlook remains quite uncertain. We believe it remains prudent at this juncture to maintain a broadly neutral stance on equities until some of these unknowns are cleared up - one way or another.
Last week was very much a week of two halves for equity markets. Global equities saw gains early on and by mid-week were brushing their all-time high in February. But markets fell back around 3% at the back end of the week, with global stocks ending the week down 0.5-1%.
The driving force behind these gyrations were the tech giants which have soared this year. The FAANGs (Facebook, Apple, Amazon, Netflix & Google) were up over 80% year-to-date at their high point before they fell back some 7% at the end of last week.
Everyone still refers to this group of stocks as the FAANGs but the fact is that this acronym is looking decidedly dated. There are two additional companies which should really also now be included in this exclusive club.
Microsoft has reinvented itself in recent years, and is once again at the leading edge of the tech sector. And who could forget Tesla whose price has risen five-fold this year. A better acronym might be FANMAG+T although Tesla is still a comparative minnow relative to the others (other than Netflix) and it’s debatable whether it should be counted as a tech company at all.
The latest setback for the tech darlings is really no big surprise given the size of the gains seen so far this year. These seem to have been inflated recently by big positions taken out by the Japanese investment house Softbank and also the stock-splits announced by Tesla and Apple – even though in theory the latter shouldn’t make any difference.
We don’t believe last week’s sell-off is a harbinger of a repeat of the bursting of the tech bubble twenty years ago. With the odd exception such as Tesla, tech valuations are nowhere near the levels reached back then. The business models of the tech giants are also much more robust now, as is their cash generating capacity. With Covid-19 only reinforcing the secular trends already in its favour, the tech sector remains well placed going forward even though it is now facing a regulatory crackdown.
Unlike with tech, another pronounced trend seen this year continued unabated last week, namely the underperformance of UK equities. UK stocks fell 2.6% and are now down a little over 20% year-to-date whereas global stocks are up 3%.
A warning from Boris Johnson and Rishi Sunak that tough times lie ahead and taxes will need to rise cannot have helped UK equities. In part, their comments only stated a blindingly obvious if unpalatable truth. The surprise was more Sunak’s intention to start raising taxes as soon as the Autumn Budget.
Such a move could only endanger the fledgling recovery and differs markedly from the policy being adopted elsewhere. France, for example, only last week announced a new €100bn economic recovery plan worth some 4% of GDP. Anyway, Sunak’s plans provoked howls of anguish from his party, with tax rises later this year now look likely to be modest in scope.
Tax increases, however, are not the only bogeyman on the horizon, with a No-Deal Brexit looking increasingly likely. Johnson has said a Brexit deal needs to be agreed by 15 October and, with both sides seemingly far apart and digging their heels in, this will be a tall order. While Johnson is still proclaiming that even a No-Deal would be a good outcome, the market is almost certainly rather more sceptical.
Global equities continued their rebound last week, rising a further 2% in local currency terms. They have now recouped all their losses earlier in the year and are back to their all-time high last seen in February.
The US Federal Reserve, rather than any economic releases, can claim credit for the latest move higher. At last week’s annual get-together of the world’s central bankers, the Fed announced a refinement of its longer-term monetary policy objectives. Rather than having a simple 2% inflation target as before, it is moving to an ‘average’ target; inflation will now be allowed to overshoot following a period of undershooting.
Over the last few years, US inflation has undershot the 2% target significantly with the Fed’s favoured inflation measure currently only at 1.2%. So, there is definitely grounds for inflation to be allowed to run above 2% over coming years and higher inflation would be good news for equities.
Past experience over recent years, however, suggests central banks will continue to struggle to hit, let alone overshoot, their inflation targets. So, the Fed’s move is for the moment rather academic and will have few policy implications for a while yet.
Longer term, by contrast, the massive fiscal and monetary stimulus does clearly carry some inflation risk. And whereas before, a rate rise had looked possible in a couple of years’ time, US rates now look set to remain close to zero for maybe at least another five years.
Rate hikes also look unlikely as far as the eye can see in the UK and Europe. Indeed, BoE Governor Andrew Bailey was at pains last week to emphasise the Bank still has ample firepower to support the UK economy if needed. Further quantitative easing is quite possible and, if absolutely necessary, the BoE could introduce negative interest rates.
Still, the sad fact is that despite the Fed’s latest move and the BoE’s protestations to the contrary, monetary policy is reaching the limits of its effectiveness. Additional stimulus may well boost asset prices further but, in terms of its impact on the economy, it is more akin to pushing on a string – to quote the old adage.
Back closer to home, one of the more notable moves of late has been the marked rise in the pound against the dollar. Sterling is now back to $1.34, up from a low of $1.15 at the height of the sell-off in mid-March. It would be nice to say that this is all down to renewed confidence in the UK economy but this doesn’t seem to be the case.
Sterling’s gains have been concentrated against the dollar, which has been weakening generally, and have been much more muted against the euro. Equally telling, UK equities have continued to underperform other markets in sterling terms, whereas normally sterling strengthening is associated with outperformance.
The underperformance of UK equities may in part relate to worries about Brexit, the winding down of the furlough scheme now underway and the government’s erratic handling of the crisis. However, it will also in part just be down to the continued outperformance of tech stocks, which account for over 30% of the market in the US but a mere 2% in the UK.
We believe tech stocks should continue to fare relatively well and thus UK equities may continue to struggle. Even so, their value does offer some hope that the bulk of the UK’s underperformance should finally now be behind us.
Global equities edged higher last week with no great enthusiasm, as indeed did US equities which inched above their all-time high in February.
Beneath the surface, however, the week was rather more eventful. Technology stocks outperformed with a gain of 2.5%, led by the mega-cap FAANGs (Facebook, Apple, Amazon, Netflix & Google) which were up close to 8%. UK equities, by contrast, were down 1.2%.
This pattern of technology outperformance and UK underperformance has been the story, not only of the past week, but the whole year. The technology sector has outperformed global equities by over 30% since the start of the year while the UK has underperformed by over 20%.
In fact, this story has been playing out for a lot longer than this year and we have just seen the passing of a depressing milestone for the UK market. The entire market cap of the FTSE 100 index is now smaller than that of Apple whose market cap has burst through the $2 trillion mark!
In good part, this is down to Apple’s share price, which is up as much as 70% year-to-date and now trades on a heady forward price-earnings ratio of 33x. But sadly, it also reflects the fact that the market cap of the FTSE 100 has gone nowhere over the last twenty years.
The FAANGs undoubtedly face increased regulatory and tax headwinds going forward. But we believe this is more than compensated by the secular tailwinds in favour of the tech sector more generally which have only been reinforced by Covid. Meanwhile, tech valuations are still nowhere back to the highs seen back in the 1999-2000 tech bubble. Consequently, we plan to retain our tech exposure.
As for UK equities, they may be cheap with a forward price-earnings ratio currently 25% lower than for the rest of the world, but there is little obvious on the horizon to trigger a major change of sentiment for the better and we remain somewhat cautious. Last week’s economic data did surprise on the upside, with business confidence improving further in August and retail sales in July above their levels a year earlier. Indeed, UK GDP now looks likely to see a gain of as much as 14% in the third quarter.
However, even such a large bounce would still only re-coup some 55% of the drop seen in the second quarter. And with the government’s furlough scheme being unwound over the next couple of months, the pace of the recovery is likely to slow considerably later in the year, particularly with Brexit lurking in the wings.
The latest round of UK-EU trade talks ended on a sour note with no progress being made. No deal, or even a bare-bones deal, at year end can only pose another unwelcome drag on the economy. Talking of which, last week saw UK government debt hit the £2 trillion milestone and exceed 100% of GDP for the first time, which only highlights the difficult path ahead for the economy.
To end on a slightly more positive note, UK and European equities are up close to 2% this morning, buoyed by talk of a new plasma treatment for hospitalised covid patients and a vaccine possibly being released ahead of the US election. Both developments are encouraging although neither will provide a silver bullet. We believe equities remain vulnerable to a possible correction over coming months, even if longer term they have more upside.
Global equities had another good week, gaining another 1% or so. In local currency terms, even if not yet in sterling terms, equity prices are now back to where they were at the start of the year. US equities have fared even better and are now up close to 6% year-to-date and are re-testing their February highs.
Markets have taken heart from the corporate earnings season, which is now drawing to a close in the US and Europe and has not been as bad as feared. Just as important maybe, equities continue to draw support from the fact that there is no real alternative for anyone looking for a half decent return given the measly yields now on offer from fixed income.
Unlike global equities, the UK did not have a good week. Just as many A-level students found their results worse than expected, last week’s results for the economy were also very much at the bottom of the class.
UK GDP contracted a massive 20% q/q in Q2. This was the largest decline seen by any major economy, with only Spain coming close with a 19% decline. The US and Germany fared relatively well with falls of the order of 10% while today’s numbers showed Japan holding up better still with a decline of a little under 8%.
However, as with the A-level results, this league table is not entirely fair to the worst performers. The UK’s dire Q2 performance in part reflected its consumer services-heavy economy but was also partly just down to timing and the relatively late date of the UK lockdown.
To the extent there was any good news, it was that the drop in output was no larger than expected. Moreover, unlike the Government which is still digging, the economy has begun to climb out of its hole. GDP rebounded in June and is already 11% above its April low point. Even so, activity remains down as much as 17% on pre-Covid levels and the speed of the rebound is likely to slow significantly later this year. Government support measures are being wound down and the initial burst of pent-up demand will come to an end.
The Chinese experience certainly suggests continued consumer caution may hamper a rapid return to pre-Covid levels of activity. China has led the global rebound and been in recovery mode for a few months now. But even here, consumers remain quite cautious with retail sales remaining lower than a year ago.
The UK Government can at least take some solace from the fact that the US response to the virus has been just as open to criticism. While infection rates are now showing signs of peaking in the US, Congress is still arguing over the content of the support package badly needed to replace the stimulus measures which came to an end in July.
The major news last week in the US, however, was political. Joe Biden announced Kamala Harris as his running mate. Biden was already ahead in the polls and this appointment can only boost his chances. Her gender, ethnicity and relative youth should widen Biden’s appeal which is rather limited by his old, white, male and gaffe-prone nature.
Biden’s poll ratings rose substantially over the last few months while he was hunkered down in his Covid-bunker. Boris Johnson must be praying for the same as he remains squirrelled away in Scotland, his hopes dashed no doubt that it would only be the midges, rather than an exams fiasco, which would be spoiling his holiday.
SUMMARY * Global equities have recaptured most of their losses from earlier this year * The massive monetary and fiscal stimulus has fuelled hopes of a V-shaped rebound in the economy * An economic upturn is underway, although, as expected, its pace has slowed following an initial spurt * We expect the recovery to be a stuttering affair, although the outlook hinges on Covid-related developments * Equity valuations now look on the high side and there is the risk of a correction over coming months * Further out, equities have additional upside and return prospects are significantly better than for fixed income * We are relatively cautious on UK and US equities but more positive on Asia and have added an exposure to healthcare * Prospective returns from corporate bonds look limited but are significantly higher than for government bonds
Last week was a choppy one for equity markets, with global equities ending the week little changed in local currency terms. A strengthening in the pound to $1.31, however, left markets down 2.0% in sterling terms.
Second quarter GDP numbers for the US and Europe confirmed the extent of the collapse in activity caused by the lockdowns. US GDP contracted a record 9.5% q/q but even so fared better than the Eurozone where GDP fell 12.1%. Within Europe, Germany was most resilient with a decline of 10.1% while Spain fared worst with a fall of 18.5%. The UK numbers have not yet been released but most likely the UK will be one of the worst hit economies.
In the US, the Fed left policy unchanged last week as expected and Chair Jerome Powell went out of his way to emphasise how dependent the path of the economy was on Covid developments. The renewal of government support measures, however, is also critical if the recovery now underway is to be sustained. Congress has as yet failed to agree an extension of the government stimulus measures which ended in July but most likely will do so over coming weeks.
The second quarter earnings season is now past its halfway mark in the US and the collapse in earnings is proving less than feared. Earnings are now expected to be down some 35% on a year earlier, compared with expectations for a 45% fall at the start of reporting. The tech sector has been a major reason for the positive surprise with Apple, Amazon, Facebook and Alphabet (Google) all reporting last week and beating estimates. Along with healthcare, the two sectors should actually see second quarter earnings up a little on a year ago – in contrast to the sharp declines being seen elsewhere.
Tech stocks have also been in the news recently because the leaders of the tech titans were testifying last week before Congress in an attempt to limit the regulatory crackdown heading their way. Increased regulatory and tax headwinds, along with higher valuations, mean the backdrop for tech stocks is no longer as favourable as it once was. Still, their latest results very much confirm the underlying growth story of the sector and we plan to retain our allocations to technology and artificial intelligence.
Currencies have also been a focus recently. For UK investors, the focal point has been the recovery in the pound against the dollar from a low of $1.15 in March to back above $1.30. This rise has been very much a result of dollar weakness rather than sterling strength with the pound losing, rather than gaining, ground against the euro.
The dollar has suffered from the flare up in Covid infections and much reduced interest rate support. With much of the dollar’s decline likely to be behind us now and the UK once again drawing closer to a Brexit cliff-edge, the pound could well unwind some of its recent gains later this year.
Last week was really a week of two halves as far as equity markets were concerned, with initial gains subsequently reversed, leaving markets down a little over the week as a whole.
A further escalation of tensions between China and the US, with the tit-for-tat embassy closure, was the most obvious reason for the change in market tone. But the continuing uncertainties over the prospects for the economic recovery may also have contributed.
Last week’s economic data on the face of it looked encouraging but in reality was rather less so. Business confidence recovered further in July and is now back above pre-Covid levels in the UK and Europe. However, these surveys basically just ask businesses whether conditions are improving or not. Given how dire the position was a couple of months ago, the fact that most businesses are now saying things are getting better is hardly a sign that the economy is back to normal.
Retail sales have also shown a sharp V-shaped recovery and in June, in both the UK and US, they had regained almost all their collapse in March/April. But again this is not as reassuring as it first looks. It is far from clear how much of this bounce just reflects one-off pent-up demand and will not be sustained going forward. Retail sales also only account for around 30% of total consumer spending. The recovery in spending on services etc. is likely to have been much more subdued.
In short, the debate over the strength of the recovery from here is alive and kicking, not least because the outlook is so dependent on how soon a vaccine is developed and rolled out and whether there is a major secondary spike in infections. Recent news has been encouraging on the former but discouraging on the latter, with infections still not under control in the US and also now picking up again in Europe.
The outlook hinges not only on the virus but also on the government’s policy response. For Europe at least, there was good news last week. At the eleventh hour after a marathon summit, EU leaders finally managed to overcome resistance from their more frugal members and agree an economic recovery package totalling €750bn or 5% of EU GDP. For the first time ever, the EU itself – rather than just individual countries – will issue debt to finance a mixture of grants and loans to EU states.
This week, it will be the turn of the US to try to agree a new fiscal stimulus package to replace the current support measures which expire at the end of July. As with the EU, the terms of the new package are being fought over tooth and nail, this time by the Democrats and Republicans.
One asset which has performed very well this year has been gold and its price rose a further 5% last week, breaking above $1900 and its previous high in 2011. The gold price is now up over 25% so far this year. Gold is the archetypal safe haven risk-off asset and one would expect it to do well in a time such as now of heightened economic uncertainty and geo-political tension.
However, the scale of its gains are down in good part to the super low level of interest rates. Government bonds used to be an obvious source of protection for portfolios in the event of a major sell-off in risky assets. Now, by contrast, the scope for further declines in yields is minimal with rates already so low, and the ability for bonds to provide such protection is much reduced. In addition, with government bonds now yielding virtually nothing, the fact that gold pays no income is no longer a particular disadvantage.
These various factors mean gold should remain well supported for the time being and could well rise further. But one shouldn’t forget that gold is volatile. If and when we do eventually see a return towards normality, gold could well retreat significantly. After all, the gold price more than doubled in the three years following the global financial crisis, only then to unwind half of those gains over the following couple of years. Finally, for UK investors, there is also currency risk associated with investing in gold with part of the latest rise in gold just a function of the recent weakness in the dollar. Gold may be a risk-off asset but it is a risky one.
Equity markets continued their upward trend last week, with global equities gaining 1.2% in local currency terms. Beneath the surface, however, the recovery has been a choppy affair of late. China and the technology sector, the big outperformers year-to-date, retreated last week whereas the UK and Europe, the laggards so far this year, led the gains.
As for US equities, they have re-tested, but so far failed to break above, their post-Covid high in early June and their end-2019 level. The recent choppiness of markets is not that surprising given they are being buffeted by a whole series of conflicting forces.
Developments regarding Covid-19 as ever remain absolutely critical and it is a mixture of bad and good news at the moment. There have been reports of encouraging early trial results for a new treatment and potential vaccine but infection rates continue to climb in the US. Reopening has now been halted or reversed in states accounting for 80% of the population.
We are a long way away from a complete lockdown being re-imposed and these moves are not expected to throw the economy back into reverse. But they do emphasise that the economic recovery, not only in the US but also elsewhere, is likely to prove a ‘stuttering’ affair.
Indeed, the May GDP numbers in the UK undid some of the optimism which had been building recently. Rather than bouncing 5% m/m in May as had been expected, GDP rose a more meagre 1.8% and remains a massive 24.5% below its pre-Covid level in February.
Even in China, where the recovery is now well underway, there is room for some caution. GDP rose a larger than expected 11.5% q/q in the second quarter and regained all of its decline the previous quarter. However, the bounce back is being led by manufacturing and public sector investment, and the recovery in retail sales is proving much more hesitant.
China is not just a focus of attention at the moment because its economy is leading the global upturn but because of the increasing tensions with Hong Kong, the US and UK. UK telecoms companies have now been banned from using Huawei’s 5G equipment in the future and the US is talking of imposing restrictions on Tik Tok, the Chinese social media platform. While this escalation is not as yet a major problem, it is a potential source of market volatility and another, albeit as yet relatively small, unwelcome drag on the global economy.
Government support will be critical over coming months and longer if the global recovery is to be sustained. This week will be crucial in this respect for Europe and the US. The EU, at the time of writing, is still engaged in a marathon four-day summit, trying to reach agreement on an economic recovery fund. As is almost always the case, a messy compromise will probably end up being hammered out.
An agreement will be positive but the difficulty in reaching it does highlight the underlying tensions in the EU which have far from gone away with the departure of the UK. Meanwhile in the US, the Democrats and Republicans will this week be engaged in their own battle over extending the government support schemes which would otherwise come to an end this month.
Most of these tensions and uncertainties are not going away any time soon. Markets face a choppy period over the over the summer and autumn with equities remaining at risk of a correction.
Global equities continued to edge higher last week, rising 1.5% in local currency terms, although a strengthening of the pound cut the gain to 0.2% in sterling terms.
The big focus for the UK was Rishi Sunak’s latest range of measures aimed at promoting the economic recovery and heading off a surge in unemployment. They included a payment to firms of £1000 for each furloughed employee they reemploy, a temporary cut in the VAT rate to 5% for the tourism and hospitality sectors, an increase in the stamp duty threshold to £500k until March, a work creation scheme for young people and - last but not least - the ‘come dine with me’ scheme.
In total, the package may cost up to £30bn and brings the total cost of COVID-related support measures introduced by the Treasury to as much as £190bn. This in turn looks likely to leave the budget deficit this year at around a massive £350bn, or 18% of GDP, almost twice the size at the peak of the global financial crisis.
These initiatives will undoubtedly help although there has been some criticism that the Government is throwing money at the problem ‘willy nilly’ and the measures are not well targeted enough. Only time will tell but certainly Rishi’s efforts did little to cheer up the UK equity market which fell 0.9% last week, continuing the weak performance seen so far this year.
Whereas global equities are now back in positive territory for the year with a return of 1.4%, UK equities have lost 18.2% year-to-date (ytd). The poor performance is down to the UK being one of the economies hit hardest by Covid, lingering worries over Brexit and the relatively large weighting of the energy sector which has suffered from the collapse in the oil price. While the bulk of the underperformance must surely now be behind us, we remain somewhat cautious on UK equities even though they remain cheap.
The big winners this year, by contrast, have been the technology sector and Chinese equities. Both areas saw increases of 4-5% last week and are up as much as 22% and 26% ytd respectively. We have favoured the tech sector for a good while now and believe Covid has only reinforced its strong long term growth story. Valuations have risen significantly but are nowhere near the levels seen in the tech bubble twenty years ago and look justifiable, particularly given the sharp fall in interest rates.
As for China, its stellar performance of late is a result of its economy suffering rather less damage from Covid than elsewhere, recent government attempts to talk Chinese equities up and the importance of the tech sector to that market. We remain positive on China although the ongoing tensions with both the US and Hong Kong are some source of concern.
This week, the US second quarter corporate reporting season kicks off and earnings are expected to be down as much as 45% on a year ago. The risk is that the increased focus on this year’s collapse in earnings calls into question the market’s hitherto optimistic view on the size of the rebound in prospect next year.
Markets continue to take heart from signs of a rebound in economic activity. Manufacturing confidence and employment in the US both posted unexpectedly large gains in June. Meanwhile here in the UK, the Bank of England’s chief economist stated that the downturn in the economy was not as severe as had been expected and activity was rebounding faster than anticipated.