Adjusting to the new normal

Last Thursday the markets were rattled, and there was no specific reason for this however, it serves as a reminder that we are not out of the woods yet. In an update with Franklin they stated that no-one knows the path of the virus, or direction of economies, and we are entering a phase where markets react to any uncertainty however slight. The reality is that even with a vaccine and treatments, this is here to stay, and people will need to adapt to a new normal whatever that might be. Likewise, markets will have to look past this period and adapt. To illustrate this, the update from LGT Vestra provides some interesting thoughts on equities going forward.

The economic data emerging in the coming days will be bad, but as economies reopen this will likely improve, and more green shoots will appear as the data gets better. The challenge for any business is whether you can make money in a more restricted environment and recover losses. Only time will tell.

This update, per previous ones, shares thoughts from different fund managers. Our next update will be at the start of July, which will be the quarterly market update with more in-depth analysis.

LGT Vestra

Reasons to be positive about equities in the medium to long term:

  • Very easy to be distracted by the noise and focus on bad news which headlines report most on and this builds over time. Positive news often gets missed or omitted
  • Compared to 12 months ago, we are in an environment that is supportive of equities. Interest rates are at levels never seen before in some economies and these are not rising any time soon. Businesses can take out loans at cheap rates and fund repayments out of growth
  • Inflation was starting to rise but is now moving back towards low, stable levels, again positive for equities as it gives consumer confidence for constructive spending
  • QE stabilises markets and provides liquidity. A world of lower interest rates and low yields forces people up the risk scale in the hunt for yield (income) which is positive for equities
  • Austerity was the tool in 2008 because interest rates were high and academic and political thought was supportive that you should not add debt. A decade on and things have changed. Monetary support is about spending your way out, Boris Johnson is an ‘infrastructure’ Prime Minister. China helped the World Economy in 2008 through infrastructure spending. It is proven to be a massive boost to GDP.
  • You can borrow at low rates and grow your way out of debt. The US has announced a trillion-dollar infrastructure spend and other economies will do the same
  • Cash funds went to their highest levels in a decade in March; but there is a fear of missing out, and as markets recover that money will come back in which will be positive for markets
  • This is all positive for markets in the medium and long term and we should not focus on tomorrow or the next week

How do we pay for the debt?

  • One way is to grow our way out of the debt
  • However, borrowing from the government is significant in the UK at the same time as revenues are coming down. Tax receipts are down 42%; of this VAT is down 107%, corporation tax down 55% and IHT down 33%. Although tobacco duty is up 138%!
  • This will change as we exit lockdown, and there are rumours that there might be a short-term reduction in VAT to kick start the recovery
  • Taxation might be way to pay back the debt, but it will have to be carefully thought out. Some areas to consider are a 1% increase in basic rate tax, and 3% or 5% increase in higher rates of tax. Ending the triple lock on state pension, freezing the personal allowance, or bringing down the £100,000 limit. Reforming national insurance including looking at increases for self-employed and national insurance on pensions. Other areas which could be targeted include pension tax relief and salary sacrifice schemes

Jupiter (Merlin Team)

About the virus:

  • Brazil is the new centre of the virus, India is struggling
  • Cases in Beijing have gone from 1 new case a day to over 30 cases, and there are states in the US where the trajectory is going up rather than down
  • In New Zealand they are using Police and Military to follow up on contact tracing following the two imported cases. But on the positive side rugby has returned to sell-out crowds
  • Germany have started using their track and trace system with great success
  • News from Imperial College on a vaccine and treatment seems positive

Economic thoughts:

  • With the drop in markets last week the VIX went from mid-20s to over 40 (this shows the volatility index of markets)
  • The debate in the UK is the shift to the 1 metre social distancing rule. The 2 metre rule limits capacity, but staffing to accommodate this means it is almost impossible to make money, the 1 metre rule makes it a little bit easier
  • 3 million of the 9 million furloughed people in the UK work in the hospitality sector and not all businesses will survive. Currently unemployment is 3.9% which will rise, but it is how you protect this from going too high
  • In the US, they expect unemployment to be above 5% in 2022. If the Fed continues with QE this year, it will have committed the equivalent of the entire German economy to the programme!
  • The US has again pushed forward a trillion-dollar package on infrastructure spending. The election is ahead full steam with the three areas of focus being Trump, the economy and equality. Polls are not looking good for the President, but there is a theory that many do not want to declare they would vote for him (the dirty secret) so it’s all to play for
  • Germany announced a 130 billion-euro package which included tax cuts, e300 to every child and a car scrappage scheme
  • In the UK, the largest group to withdraw money from markets in this crisis has been the over-60s. At that age, life expectancy is still potentially another 20 or 30 years. They believe it is madness to take money out of the markets now, and it is ‘time spent in the markets’ that is more important than ‘timing the markets’ and investors need to be patient and stay invested. Values will recover.

ESG:

  • ESG has been supercharged by COVID19
  • The initial focus was on the ‘G’ – Governance – quality of the balance sheet, liquidity, debt, dividends etc
  • The second phase has been on the ‘S’ – Social – focusing on how companies have handled stakeholders, staff, suppliers. The treatment of staff is really important with equality being pushed more into focus
  • The third phase will certainly shift to ‘E’ – Environmental – governments are likely to focus infrastructure spend on green projects
  • It is clear that now is the time to challenge companies, hold them to account and make them change, which benefits them, but it also investors and society

ASI (ESG Team)

Some thoughts around sustainability and long-term impacts:

  • Since 2008 there has been a steady increase in wind and solar power generation; China has gone from 0.3% to 8%, the US from 1.4% to 8.9% and EU from 3.5% to 15%
  • China has the highest use of electric vehicles of 4.7%, EU is 3.6% and US 1.9%
  • They expect that the government support for green infrastructure will not only continue but increase significantly as Governments spend their way out of this recession
  • The social inequalities in both developed and developing economies has increased as a result of COVID-19. The global poverty line is US $5.50 a day; those who have fallen 20% below this line have increased by 548 million people during this crisis. They believe this will lead to social action both by governments and companies
  • They believe that social action will also be led by investors who are likely to not want to reward those companies who have poor social governance
  • The market especially during this period has recognised the importance of ESG and rewarded those companies with better credentials, which will just accelerate
  • Long-term they believe investors will want investments which offer not only strong financial returns but also deliver a positive impact in the world around us

Liontrust (Asia Team)

Signs of improvement in China:

  • Approximately 93% of workforce back at work by the end of April
  • April industrial production +3.9% YOY (year on year) after March decline of -1.1%
  • April industrial profits -4.3% YOY vs March decline of -34.9%
  • Middle bracket restaurants are 70-80% full, but at 60% of original capacity
  • On 14th February there were 32,248 new COVID cases; on 15th May this was 62
  • Shanghai Disneyland land opened on 11 May at 30% capacity and sold out in minutes

Somerset Capital Management (EM Team)

High level thoughts:

  • There have been $80 billion of outflows from EM, this is 3 times the level of 2008. $20 billion of that has come from Brazil
    Emerging markets are at their cheapest level relative to the US since 2001
  • There has been a big variation in performance where balance sheet weakness has depressed returns – for example, Brazil is down -43.07%, South Africa -31.29% and China is down -5.02%. The index is down -15.96%. China has come out of this in the strongest position of this group.
  • They argue that LATAM tends to perform better in the recovery; in 2008 – 2010 it outperformed the index by 27% and in 2002 – 2004 it outperformed by 44%
  • They believe inflationary pressure, abundant liquidity and less USD strength should be tailwinds for Emerging Markets

JPM (Market Watch)

Reasons to be optimistic:

  • April is likely to be the worst month, May is likely to show a strong bounce as countries exit lockdown
  • US retail sales and food services have bounced back; the community mobility index (which considers movement across areas like retail and recreation, groceries and pharmacies, parks, transit stations, workplaces, and residential) in the US is up as are ‘big-ticket’ items
  • In Europe it seems policymakers are not going to repeat the mistakes of 2011, and the EU recovery fund is a positive sign. Lagarde has continued to move the ECB to being a forward-thinking central bank
  • In Europe, labour schemes have been a lot better than those in the US. Europe is de-restricting lockdown and sectors like manufacturing have seen a big bounce in recovery

Reasons to be careful:

  • There are signs of increased levels of infections in China, and some US states. Governments are not going to lockdown again but how they control these infections is important
  • European states are opening and the news is positive, but in the US the data in areas like Arizona, Alabama, Florida is worsening
  • The UK Government looks certain not to ask for an extension to Brexit; they seem confident a deal will be agreed so expect more volatility in the Autumn
  • In the US employers are finding it hard to get people back to work because of the generous employment schemes

Invesco (Economic Team)

Some thoughts from the team:

  • April should be the global trough with sharp recoveries expected in Europe and the UK in May, but still deep in contraction territory
  • Believe in a U / W shape recovery, W will reflect a second wave and how that impacts economies
  • They think economies will recover at different rates, for example those linked to tourism will take longer
  • There is a move in the recovery from quality stocks (especially US tech) towards small cap, financials, energy, industrials, value and cyclicals – they do not think this recovery is sustainable
  • On a positive note, they see the virus backdrop improving, gradual re-opening of economies, monetary support (never fight the fed). Investors remain underweight in equities and there is a wall of cash waiting to be invested
  • Negatively, they think there will be lasting damage to economies, there could a second wave and recoveries are never straightforward or swift
  • They think markets may have got ahead of themselves and there could be a pause or retraction. Over the medium term, there is room for further upside especially with cash waiting to go into the market. However, investors need to be aware markets are vulnerable to negative news
  • The end of June is the date to watch for Brexit, markets seem to be tilted towards a deal. If a deal is struck, then sterling would recover losses, if no deal, then sterling will retest the lows

Franklin (CIO Insights)

Thoughts:

  • No one knows the path of the virus or economies; this is a difficult phase and markets will react to all the uncertainties that arise
  • As we head into the summer expect positive news but do not get carried away. These just reflect the re-opening
  • Autumn/Winter could be harder as reality sinks in – more unemployment, the inability to replace lost demand and revenue and as this is a global issue it means no V shape recovery
  • We need to consider the long-term implications of massive deficits as these have never been good for economies
  • Do not see negative interest rates as a useful tool. Short term they think inflation is unlikely, but long term it could become a problem
  • Biggest long-term concern is highlighted in the US with a divided nation, coupled with high unemployment will become a big challenge. This is likely to be reflected globally and nationalist elements could worsen which is not good for markets

Schroders (Economic Team)

Thoughts:

  • They believe the second quarter will be the trough, and the bounce back will come in the third and fourth quarter
  • They now believe the recovery will not be as vigorous as they first thought and believe in a U shape recovery with economies not recovering until 2022
  • They believe there are challenges with unwinding lockdown especially in the US where the number of cases has increased. There are concerns that consumers and corporates hoard cash and as Governments unwind schemes more people will be laid off
  • More positive about Europe and the potential for a pan-European fiscal policy, there are still hurdles but this is heading in the right direction
  • In terms of China/US they think much of the noise is to divert away from the US economy and ripping up the phase one agreement would not benefit the US
  • If the Democrats have a clean sweep in the election the markets are unlikely to respond well in the short term
  • They expect a pull back in the US dollar and for this to get weaker especially with low interest rates
  • US unemployment figures are positive news, and the Fed’s recent action on buying credit direct rather than via ETFs shows the Fed back stop is definitely in place

T Rowe (Economic Team)

They started by saying we need to be comfortable with the uncomfortable.

Thoughts on the US:

  • Wide range of economic outcomes from state to state – worried because states employ many thousands of people, and if they get into economic problems it could increase unemployment significantly as budgets come under pressure
  • There are also concerns that the US is made up of many smaller companies and how these survive especially within the service sector
  • However, they think we are at an early stage of recovery although markets are ahead of themselves – they find it strange that markets are close to breakeven which might be due to the progress on controlling the virus, on a vaccine, fiscal stimulus, states reopening (which may cause its own problems!), and positive unemployment data

What are the challenges for the US?

  • Unemployment will be over 10%, and there will be massive deficits to get people to the other side (Government spending to drive the recovery)
  • 70% of US GDP is consumer spending and there is evidence that people are saving and not spending
  • There are growing tensions between the US and China
  • Growing unrest domestically around racial injustice

Other thoughts:

  • The velocity of money coming into markets from QE and other fiscal measures could drive markets higher
  • Emerging trends of the last ten years have been compressed into two weeks with maximum liquidity being the key to survival
  • Any reversion to energy and financials is short term – old energy faces challenges from new greener forms and financials are challenged by lower interest rates
  • There is no longer an argument between value and growth – simply more capital-intensive companies will be penalised going forward
  • Income inequalities have been forced to the front – it is the lower income bracket who have been hit hardest and where the greatest unrest lies

Note: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.

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