By Tim Sharp, Hottinger Investment Management
At the height of the summer, markets tend to become a little more volatile because of lower trading volumes and our thoughts turn to what is on the horizon. 2nd quarter earnings saw US companies outperform Europe and mega-tech continues to lead markets. The mix of traditional companies and new probably explains this phenomenon rather than any overriding policy success by the Trump administration. The outperformance of mega-tech can probably be attributed to its many facets – providing the investor with companies that have benefitted from the pandemic lockdown; consistent long-term growth outperformance; significant cashflow generation and minimal debt. The combination of superior growth and defensive qualities has led many investors to continue to support the sector despite expensive valuations.
Conversely, the performance of Europe as it re-opens has caught the attention of investors and may be the catalyst for a rotation into more traditional sectors. Europe went into a strict lockdown that likely resulted in the underperformance in the 2nd quarter. Policies that have kept workers employed, rather than on subsidised unemployment benefits, have allowed for a stronger re-opening; populations are higher in confidence and more likely to consume and so business confidence has also bounced back strongly. Efficient track and trace systems have allowed for better control of secondary outbreaks such as the latest global increase in new cases. Furthermore, the political agreement on the EU Recovery fund should provide a more stable and predictable platform for monetary and fiscal stimulus instead of meeting resistance at a national level. The banking system remains the backbone of corporate lending in Europe unlike the US where the bond markets are more accessible to small and medium sized firms. Therefore, banks remain key to a sustainable European recovery and, as Absolute Strategy Research (ASR) write, European banks will need to remain good investments[i].
The US Federal Reserve has successfully provided the corporate bond market with support which is probably the reason why high yield and investment grade spreads have not widened in line with the tightening in US bank’s lending standards to corporates, despite an increase in the default rate. This suggests that many companies are being propped up by cheap lending when perhaps their solvency should have been brought into question, creating yet another signal that is being masked by central bank or government intervention.
The rally in gold this year to a peak over $2000 /oz started due to the metals safe haven properties but with near zero interest rates in most of the developed world, a significant drop in inflation rates and, most recently, a depreciating dollar, the gold price has continued to strengthen as an alternative to bonds. But, now that there has been an increase in inflation expectations due to the significant levels of stimulus pumped into economies, the main danger with this strategy is that gold has no protection from inflation either, so when inflation does come back gold may well react in a similar way to equities.
The dollar saw its worst month for about a decade in July losing 4.15% having slowly depreciated against most developed currencies since March. Coupled with the nascent signs of recovery in air freight and shipping container volumes this would point to early signs of a recovery in global growth. Before the pandemic we were exploring the drag on the recovery in global growth caused by a strong dollar, so it is probably no coincidence that this has occurred particularly in Asia where China looks to be the only country to post positive growth in 2020. In March we witnessed the safe haven qualities of dollar ownership at times of stress so we are reluctant to turn away from the dollar when the worst of the pandemic lockdown may yet come to pass as government support starts to be lifted over the coming months.
Judging by recent growth statistics, the UK economy has performed poorly compared to other G7 countries due to a mixture of uncertainty regarding European trade talks and the UK government approach to the pandemic continuing to cause concern. This can also be attributed to much of the UK economy being service sector focused rather than manufacturing. Large swathes of the UK economy remain closed especially in the hospitality, tourist, and entertainment sectors and over 6 million remain furloughed. This has also translated into similar poor returns from UK financial assets leaving them a drag on global, multi-asset portfolios. The UK main indices are also overweight with oil, mining and banking stocks which remain unloved, deep value plays. There are some good UK companies performing very well in growth sectors, but it takes good stock-picking to build a highly valued portfolio rather than passive, index investing.
Finally, we believe that it is unlikely that the world will return to its pre-Covid position and that a new normal will prevail. We have previously commented on the lack of collaboration during the Covid-19 outbreak and we believe that countries will become increasingly isolationist. Should President Trump win a second term, which is an outcome less explored by investors than a Biden win, then it is likely that relations between the US and China will cool further, with the likely complication of competing standards regulating different industries and its inevitable effects on global growth. ASR believe it is also likely that supply chains will shorten, moving from being cost conscious to security conscious[ii]. Companies could look to primarily guarantee production lines rather than cost efficiencies, which may have material effects on the future growth of emerging markets. We have also just witnessed the politicising of a vaccine with the announcement by Russia of the success of their Sputnik 5 Covid vaccine. If successful vaccines are offered in the near future, there is therefore the possibility that they may not be accepted globally without other countries undertaking their own testing. For example, in the current environment it seems unlikely that the US would trust a Chinese vaccine, regardless of how genuine and transparent the testing results are. This was recently referred to by the World Health Organisation as “vaccine nationalism”[iii], and as such, it is probably a good thing in this increasingly isolationist world, that there are so many Covid vaccines being tested globally if it is to be working vaccines that offer the best chance of countries returning to normal activity levels once more.
[i] Absolute Strategy Research – “Banking” on Eurozone Equities – August 6, 2020
[ii] Absolute Strategy Research – Investment Committee Briefing – August 7, 2020
[iii] https://www.msn.com/en-gb/money/technology/who-chief-concerned-about-vaccine-nationalism/vi-BB17VKrl
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