Author: admin@hottinger.co.uk

By Tim Sharp, Hottinger & Co.

As we started the New Year the reflation trade was already underway with commodities and resources stocks showing a strong performance and the 10-year US Treasury yield rising back above 1%. Markets were happy that the Presidential Election in November had not resulted in a “blue wave”. However, by Inauguration Day the Democrats’ sweep as a result of the Georgia Senate elections was instead seen as the path to higher stimulus due to the seriousness of the escalation of the pandemic taking centre stage. Banks are still supporting financial markets, government fiscal stimulus continues to support economies in lockdown, and the roll-out of the vaccinations can be viewed as a third stimulus, shortening the path back to normality.

 

Albeit slightly dimmed due to uncertainty, the light is now visible at the end of the tunnel. With continuing high levels of stimulus and evidence that the majority of investors share very similar expectations for the coming year, it is of little surprise that the return of inflation has emerged as the main risk to the central scenario. The threat of another “taper tantrum” as in 2013 could affect risk assets negatively, so the biggest risk for governments and central bankers is that any change in policy that feels like a tightening of conditions could trigger a surge in Treasury yields. A more aggressive rise in 10-year US Treasury yields to 1.5%, or even 2% in the medium term, could see investors become more nervous, while an orderly rise in yields due to a mild rise in inflation could still see risk assets thrive.

 

Our original thesis, that the reopening of economies would see risk assets continue to perform during the first half of the year before absolute valuations become relevant, is being challenged by the continued lockdown of major economies under the weight of new, more virulent strains of Covid-19. The first week of the year saw the beginnings of a New Year rally, with the MSCI World gaining 2.5% before the weight of the pandemic came to bear. Renewed global lockdown measures will have probably suppressed the economic recovery trade, and the optimism of investors towards a return to a semblance of normality is slipping, as the realisation of the here and now is brought sharply into focus. The question now is whether the recovery will be affected by further delays or whether the pent-up demand from consumers unable to spend will be just as strong but over a shorter time period.  Absolute Strategy Research (ASR) has raised their US growth forecast for the year this week from 3.5% to 7%, based on the stimulus package being proposed by the Biden administration, and Global nominal GDP to grow around 8%ii.

 

We are currently in the middle of fourth quarter earnings reporting and so far, the results have been very encouraging. Bank Julius Baer report that S&P500 earnings have come in well ahead of expectations both in strength and breadth. The bank now expects Q4 will show a decline of 2% year-on-year vs. -8.8% at the beginning of the earnings period, and guidance for the first quarter suggests 82% will guide ahead of market expectations vs. a historical average of 33%[i]. This chimes with December manufacturing PMI’s also looking strong, including new orders and prices paid, although services indices remain weak. Earnings surprises to the upside will give further confidence to investors that 2021 overall will be a favourable climate for risk assets despite the impatience currently on display. IBES global twelve months forward earnings are now forecast to rise 26%, and ASR also suggest a central forecast for global earnings-per-share of 25% year-on-year in 2021[ii]. Most developed equity market indices have fallen off in the second half of the month. The NASDAQ Composite clung to positive territory, up 1.4%[iii] on the month, the S&P500 was down 1.1% and the UK FTSE All-Share and German Dax finished down 0.9% and 2.1% respectively. Asian markets have fared better as they have dealt with the third Covid-19 wave more effectively. The Korean KOSPI Index was up 3.6% in January, the Nikkei 225 Index +0.8%, and the Shanghai Composite Index +0.2%.

 

We still believe that the environment favours equity risk on a relative basis and absolute valuations will be overlooked until major economies have re-opened. The main challenge for multi-asset investors as to how to off-set equity risk and volatility becomes more acute as valuations are further stretched. The traditional 60 / 40 portfolio has never been more questioned not just because of equity growth, but the inability of government bonds to hedge performance risk due to their own expensive valuations. The situation is arguably different in each developed economy depending on the Central Bank view on the use of negative rates. In Europe, negative rates have been a well-used monetary tool leaving 10-Year German Bund yields currently at -0.51% offering questionable support to investors anxious of equity valuations. In the US, the Federal Reserve has been adamant that negative rates are not appropriate, even under intense pressure from President Trump in 2020, meaning that while the zero bound is unlikely to be penetrated ten-year yields of 1% also offer little protection to investors. In the UK, Bank of England governor Andrew Bailey has refused to rule out the use of negative rates, but with 10-year Gilt yields at 0.33% the level of plausible protection is still low. Therefore, allocating effectively away from government bonds in order to offset potential equity volatility may need ingenuity and an understanding of the alternative asset space.

 

From a macroeconomic perspective, the Covid-19 pandemic has the potential to see the 2020’s evolve much differently than the 2010’s. The long and sophisticated supply chains that have developed through globalisation have proven fragile in the face of a pandemic, encouraging many companies to shorten or onshore their manufacturing processes, potentially raising costs and adding to the upward pressure on inflation. The result of QE has clearly bolstered financial markets with questionable effect on the real economy, whereas the switch from monetary to fiscal policy will inject funds directly into the real economy again adding to the long-term upside pressure on inflation. Finally, we enter the 2020’s with much higher debt levels as companies and governments make use of cheap debt, leaving government debt levels in most developed nations at levels unprecedented during peace time. One of the ways of reducing debt is to inflate it away, and some recent central bank policies suggest that inflation may be allowed to run above trend creating negative real interest rates in the longer term. Real assets have also started the year mixed with Gold challenged by real interest rates and a stronger dollar down 2.7%[iv], Brent crude oil is up 7.9%, while a broad basket of commodities is 2.6% to the better.

 

Preliminary discussions into allocating to Alternatives at the expense of government and investment grade corporate bond exposure, has covered Macro Fund strategies, capital protected structured products, and managed futures or CTA’s (Commodity Trading Accounts). The inflation protection offered by real assets has caused us to increase our direct commodities exposure already, but managed futures potentially offer further protection against volatility, and astute Macro funds managers have historically offered downside protection during equity bear markets.  While government bonds may still offer an element of diversification there is less protection available when equities are under pressure, and they are vulnerable to a potential pickup in inflation risk. Therefore, it is becoming more important for us to consider how effective a strategy current asset allocation is at mitigating equity market downside risk and the options that are available.

[i]  Bank Julius Baer, THE WIRE – Europe Bell, January 26, 2021

[ii] Absolute Strategy Research, Bonds at Risk as Policy Goes “Big”, January 28, 2021

[iii] Asset pricing and performance data sourced from Bloomberg

[iv] January 2021, Gold – XAUUSD:CUR,  Brent crude – CO1:COM, Commodities – BCOMTR:IND

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By Tim Sharp, Hottinger & Co.

By the end of November, the MSCI World Equity Index had reached a record high, having gained 12.7% in November as three surprisingly positive vaccine test results removed two key sources of uncertainty for investors. By the time the Investment Committee had convened in December the Pfizer / BioNTech vaccine had received emergency approval in the UK and the US with the first vaccinations underway. Furthermore, The Federal Drug Administration (FDA) has approved the Moderna vaccine for emergency use in the US, increasing the options and potential doses available, and the EU has also now approved the Pfizer / BioNTech product. While there may be light at the end of the tunnel, the journey may not be smooth with a potentially tough winter ahead before widespread vaccinations can be rolled out. Renewed lockdown measures in Europe, the UK and the US in the face of a third wave, including the discovery of a new variant of the virus in the UK that has seen travel tunnels and borders from the UK closed, will have already suppressed economic recovery, especially in the areas of economies in desperate need of holiday revenues to survive a crippling year.

On balance, it is likely that fourth quarter growth will slow in the developed world as a result of the most recent lockdowns and restrictions, flash PMI’s were already slowing, and this loss of momentum leaves risk assets in a quandary. Equity market valuations remain historically very expensive despite strong earnings in the third quarter, value as a factor still remains depressed although its outperformed growth by 4% in November, and Europe was the biggest regional beneficiary as the post-vaccine rotation got underway. However, December has seen a partial reversal of the rotation trade once more as the pandemic restrictions are toughened further in an attempt to keep new cases under control. All asset classes are expensive on a relative basis which may explain why equities have broken to the upside on the vaccine breakthrough and 10-year US Treasury bond yields have backed up towards 0.90%. In December so far, the MSCI World is 2.0% to the better leaving it over 10% up year-to-date. An effective vaccine will eventually allow the services sector activity to normalise but in the meantime do investors focus on the immediate, or the fact that we have a timeline to return to normality?

On December 11, the 27 EU members approved the $1 trillion EU budget including the coronavirus stimulus package, and the European Central Bank added $600bn to its bond purchasing stimulus programme. The December US FOMC meeting showed forecasts for inflation and growth moving higher into 2023 while confirming that interest rates would remain on hold, showing the willingness of central bankers to keep the environment accommodative[i]. Furthermore, on Sunday December 20 Congress agreed a new $900bn stimulus package which will avert a government shut down before the holidays, providing more evidence that the headwinds that have threatened to de-rail risk assets are dissipating. While new stimulus packages are still providing support to economies, and vaccines are shortening the bridge to normality, the risks of economies overheating in the medium term are to the upside.

The biggest risk for governments and central bankers is that any change in policy that feels like a tightening of conditions could trigger a “taper tantrum” similar to the surge in Treasury yields experienced in 2013. The reflation trade experienced in October has largely been reversed by the rise in new virus cases this month, and Europe is still suffering deflation. However, a more aggressive rise in 10-year US Treasury yields to 1.5%, or even 2% in the medium term, could see investors become more nervous, while an orderly rise in yields due to a mild rise in inflation could still see risk assets thrive.

Should bond yields surprise to the upside, the path of risk assets may be upset because it has been the falling bond yields that have propped up equity markets by protecting the equity duration trades in technology and healthcare. Although we believe it is unlikely that inflation becomes a problem in 2021, it is the threat that higher inflation uncertainty is skewed to the upside that can cause financial markets to react. We have already highlighted that commodities are a useful inflation hedge for investors and the Bloomberg Commodity Index has returned 3.6% month-to-date although still down 5.6% since the beginning of the year, and gold has regained some of its composure after a poor November to be up 5.25% so far in December reflecting market anxiety at the current news flow.

The final risk to the continuation of the rally in risk assets was highlighted in the recent Asset Allocation Survey carried out by Absolute Strategy Research (ASR). According to ASR, the survey represented the most bullish outlook that they have recorded in the six years that the survey has been running with the highest level of conviction[ii]. The risk is that if everyone is looking for the same outcomes and is positioned the same way, then who is making a market?

Despite the downside potential, we believe that the vaccination programme has the capacity to turn the K-shaped recovery that we have seen during the pandemic into a U-shaped recovery in the first half of 2021, as the valuation gap between the COVID “haves” and “have nots” is given the opportunity to close. The likelihood, in our opinion, is that risk assets remain in favour during the first half of 2021, but eventually absolute valuations cannot be ignored, unless earnings expectations can justify higher levels.

At the time of writing EU-UK trade talks are still continuing in overtime, but the signals from EU President von der Leyen and Prime Minister Johnston suggest that there is now a narrow pathway to a potential deal. The UK parliament has been put on alert to reconvene to debate a potential bill and sterling had strengthened on the positive tones emanating from the main protagonists. Since the start of October, £2.4bn have been pulled from UK equity funds by investors fearing a no-deal outcome, £30bn since the referendum, meaning UK risk assets are under-owned by global investors despite the deep value opportunities being presented[iii]. Brexit uncertainty has caused four years of underperformance by UK risk assets, and if there is a light at the end of the tunnel there may be some interesting opportunities for investors. Month-to-date, the FTSE All-Share Index is up 2.6% while the German DAX Index is down 0.7% and the France CAC 40 Index is -1.4%.

Elsewhere, President Xi has recently suggested that China could double its GDP by 2035 and, while we think this is unlikely, there is little doubt in our minds that China will be the engine for growth in 2021[iv]. The knock-on effect of the increased investor interest in the region especially as China’s weighting in global indices increases, will likely have a positive effect on Asian economies and financial markets. The MSCI Asia ex Japan Index is up 3.4% month-to-date and 19.6% year-to-date showing that investors are already pricing in the reflation trade in the region.

It looks as if developed equity markets will finish the year on a sour note as immediate anxieties dominate developments, but with the passing of the Winter Solstice we may start to see brighter days ahead.

[i] Morgan Stanley Research; December FOMC – Quick Takeaways; December 16, 2020

[ii] Absolute Strategy Research; Q4 2020 Asset Allocation Survey – the Great reflation Trade of 2021; December 10, 2020

[iii] https://www.ft.com/content/fa786784-f60f-43a7-b0e0-71382dcddc82

[iv] https://www.bloomberg.com/news/articles/2020-11-03/china-s-xi-says-economy-can-double-in-size-by-2035

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By Tim Sharp, Hottinger & Co

At the time of writing investors are anxiously weighing up the chances of the UK – EU negotiators brokering a trade deal in this week’s make-or-break talks and sterling continues to be the main Brexit barometer. We seem to have had many rounds of make-or-break negotiations, but most people would agree that time is now close to running out for a trade deal to be ratified by the 31^st December 2020 deadline.

On Tuesday, Boris Johnson’s government pulled parts of the Internal Markets Bill that breached the existing Withdrawal Agreement. This followed a separate deal brokered by Cabinet Office Minister, Michael Gove, and EU Commission vice-president, Maros Sefcovic, regarding the implementation of the Northern Ireland protocol. The move was supposed to be seen as a grand gesture that signaled the UK’s willingness to compromise on the outstanding issues. Nevertheless, an impasse has led to Johnson himself joining his negotiating team in Brussels for the final push, arranging dinner with EU President Ursula von der Leyen for tonight.

It is no secret that the results of the talks this month could be instrumental in deciding the UK economy’s path to recovery and the monetary and fiscal policies that will need to be employed. Back in May it became obvious that the central bankers of the major economies were considering the potential effects of implementing negative interest rates based on the experiences in Europe. In the UK, the Bank of England (BOE) Governor, Andrew Bailey, originally felt it necessary to be quoted suggesting that he was not contemplating such a move, before stating that negative interest rates could not be ruled out. The increase in sterling volatility has been attributed to investor fears that a no-deal could see the UK’s economic contraction worsen and could lead to the introduction of a negative interest rate policy by the UK central bank.

In its latest Economic Outlook Report in November, the OECD forecasts the outlook for the UK to be the second worst amongst the 20 largest national economies, including the eurozone, except Argentina. The UK is expected to still be 6% below its 4^th quarter 2019 position by the end of 2021 having contracted 11.2% in 2020 and only forecast to grow 4.2% in 2021. In its assessment the OECD considered the UK economy to be at a “critical juncture” with Brexit, cited as the biggest downside risk to its forecast.[i]

The UK Government’s independent spending watchdog the Office of Budget Responsibility released a report in November that stated that “no deal” was a “material risk” that would reduce UK GDP growth in 2021 by 2% as well as push unemployment over 8%. Their forecast for 2021 economic growth would, therefore, fall to 3.5% following temporary disruption to cross-border trade. In its main forecast the UK economy returns to its pre-crisis level by the end of 2022 but in a case with no negotiated EU trade deal, this would be pushed out to the end of 2023[ii]. Furthermore, the BOE has warned that the transition to new arrangements will see UK GDP cut by 1% in the first quarter of 2021, and it is estimated that only 70% of companies are ready for the changes.[iii]

For those who harbour a mistrust of forecasters and statisticians perhaps the view of equity investors may provide an alternative view on the outlook for the UK under new arrangements. Year-to-date, the S&P500 index in the US is up 14.50%; Japan’s Nikkei 225 is also up 13.36%; the Shanghai Composite Index is +10.55%; the German DAX is up 1.31%; the SMI Swiss index is down 1.58%; Italy’s MIB index is -5.88%; in France the CAC40 is down 6.42%; while the FTSE All-Share index is down 11.3%. Clearly, investors believe that the effects of a no-deal will hang heavier on the UK than its European counterparts and have allocated away from the UK stock market despite the international bearing of the Top 100 companies.

Karen Ward, chief market strategist, EMEA, JPMorgan Asset Management, believes that sterling would fall by 10% in trade-weighted terms in the event of no-deal, and it is assumed that the value of repatriated overseas earnings, therefore, rises. As 77% of FTSE 100 revenues are earned abroad then, by definition, the value of the FTSE 100 index should appreciate, and many money managers are recommending favouring blue-chip companies with significant overseas earnings in the event of a no-deal[iv].

However, Karen Ward points out that over the past 10 years the relationship between index returns and trade-weighted sterling has had an average correlation of close to zero and sometimes negative[v]. 40% of FTSE 100 revenues come from Europe, 27% from the US and 30% from Asia and Emerging Markets, and the index is disproportionately weighted towards financials and resources. Therefore, any effect on global sentiment from the breakdown of talks that leads to the protraction of global economic weakness could be the worst-case scenario for the UK’s main index.

However, in the light of vaccine optimism we have witnessed the beginnings of a rotation away from technology and healthcare sectors into sectors that will benefit from the re-opening of global economies such as consumer cyclicals and consumer discretionary. The FTSE 100 index has a number of dynamic consumer goods companies with global revenue streams and brand loyalty that have proven resilient in a changing environment, and, in our opinion, should continue to do so.

Despite the optimism of the most fervent Brexiteers we hope that the negotiators can over-come the remaining hurdles at a time of great flux, for the greater benefit of economies and markets alike.

 

[i] https://www.theguardian.com/business/2020/dec/01/government-covid-oecd-uk-growth-forecast

 

[ii] https://www.independent.co.uk/news/uk/politics/brexit-no-deal-uk-economy-boris-johnson-b1761709.html

 

[iii] https://uk.finance.yahoo.com/news/bank-of-england-monetary-policy-report-brexit-impact-uk-economy-094922126.html?guccounter=1

 

https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-report/2020/november/monetary-policy-report-nov-2020.pdf?la=en&hash=0CD444F53D57E0C3660AC34666D8F88CC1C6E81A

 

[iv] https://www.thisismoney.co.uk/money/investing/article-8994163/MR-MONEY-MAKER-Deal-no-deal-Brexit-strong-ramifications.html

[v] https://www.ft.com/content/1964afce-f4c5-49dc-86c4-95b62fbf46bf

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By Kevin Miskin, Hottinger & Co

We concluded last month’s investment review with the opinion that whilst October had ended in a sombre mood, as the second wave of Covid-19 gathered pace, November could be a pivotal month with the US going to the polls and there being some hope that news regarding a vaccine could be on the horizon. A few short weeks later and the MSCI World Equity Index has reached a record high, having gained 12.7% in November, as a well-received US election outcome and three surprisingly positive vaccine test results removed two key sources of uncertainty for investors.

In the weeks before the election, investors had adopted a positive view of the prospect of a Democratic “blue wave” delivering the key to unlock additional fiscal stimulus. However, as is became apparent that the Republicans would likely retain control of the Senate, barring the Democrats winning in Georgia on January 5th, investors changed tack to focus on the benefits at a company level, with President-elect Biden’s ability to pursue interventionalist policies restrained. Investors also remained sanguine about the outgoing Administration’s post-election disruptive policy decisions, including the Treasury’s termination of some of the emergency lending facilities that were put in place as a response to the pandemic and Donald Trump’s executive order prohibiting US investors from holding shares in companies with suspected ties to the Chinese military.

Whilst the election result would have dominated the news in most months, it was the announcement of surprisingly effective vaccines from Pfizer / BioNTech, Moderna and Oxford / AstraZeneca that proved the real game changer for markets. Equity markets soared and the ten-year US Treasury rose to nearly 1%; levels not seen since last March. Sectors that stand to benefit most from the reopening of economies, including autos and construction materials posted double-digit gains, but it was the banks and energy companies that lead the way. By contrast, this year’s beneficiaries of the pandemic including technology, healthcare and staples lagged. Barclays attributed the flight to value stocks as mainly short covering rather than an outright shift away from growth stocks by long-only investors, the vast majority of whom missed the sudden rotation. Nevertheless, the recent movement should be welcomed as it has improved the breadth of the market [i].

The swift rotation also brought an unfamiliar look to the monthly geographic performance tables with the growth-biased Chinese (CMI 300 +5.6%) and US (S&P500 +10.8%) equity indices lagging those in the UK (FTSE100 +12.4%) and Europe (Euro Stoxx 50 +18.1%), where value is more prevalent. Yet, to put the last month’s moves into perspective, the S&P500 has gained 12.1% this year and broke through the 3,600 level in November to record a new all-time high, while over the same period the Euro Stoxx 50 is down by 6.0% and the FTSE100 is struggling to break through 6,500, having started the year above 7,500.

Gold was out of favour amid the more positive environment and declined by 5.4% during November, representing its worst monthly performance in four years. The progress in the search for a vaccine has reduced uncertainty and could result in higher real yields, both negative developments for gold. We continue to hold the yellow metal in portfolios for diversification and to hedge tail risks [ii].

While there may be light at the end of the tunnel, the journey may not be smooth with a potentially tough winter ahead before widespread vaccinations can be rolled-out. Renewed lockdown measures in Europe are having the desired effect in suppressing the virus, but at a cost. Mobility data has slowed and the European Commission has lowered its previous recovery projection for 2021 by 2 percentage points to just 4.1%.

In the UK, chancellor of the exchequer Rishi Sunak announced the economy would shrink by 11.3% this year, the largest contraction in 300 years, and warned that fiscal consolidation may eventually be necessary. Meanwhile, the Office of Tax Simplification, which advises the government on improving the tax system, has recommended the rate that investors pay on realised gains (currently 20% for the highest earners) should be more closely aligned with income tax, where the highest rate is 45% [iii]. Any such moves could lead to interesting discussions within the Tory party where some of its MPs are already mobilising to warn the chancellor against touching taxes on profits, capital gains or pensions [iv].

In the US, even before the vaccine news came to light, the speed of the recovery had exceeded forecasts. In April, the IMF predicted that the economy would contract by 6% this year, but recently scaled back the severity of the decline to 4%. Meanwhile, unemployment peaked at 14.7% in April before declining to 9% in June, where the Federal Reserve had expected it to remain until year-end; it has continued to decline and currently stands below 7%. America is not expected to suffer a double-dip recession, unlike Europe, and will probably not impose lockdowns as severe as those across the Atlantic [v]. Nevertheless, tighter restrictions are being implemented in individual states as cases continue to rise, while the infection rate in the days following Thanksgiving will be closely monitored.

On balance, it is likely that Q4 growth will slow in the developed world as a result of the most recent lockdowns and restrictions, and this loss of momentum could carry into the early part of next year before vaccinations are rolled out. Therefore, looking at a six-month time horizon, we would continue buy equities in the event of any pullback in the short-term.  A major question is whether the recent rally in value stocks has legs.

The key could lie in the government bond market. Ten-year yields spiked higher immediately following the initial vaccine news from Pfizer before ending the month broadly unchanged. A rise in long-dated government bond yields as a result of stronger economic fundamentals weakens the case for paying a premium for growth companies, while a steeper yield curve would unlock banks’ revenues through a revival in net interest margins. For the recovery in Value to be sustainable, yields would need to move higher. This scenario is not inconceivable with the US 10-year Treasury yielding sub-1% at a time when the US economy forecast is to grow by 7.5% next year, according to Morgan Stanley [vi].  Of course, any recovery will have to be backed-up by earnings but with revenues having been decimated in many value companies this year, the bar should be set relatively low in 2021.

[i] Barclays – Equity Market Review – Hope vs. reality; November 20, 2020

[ii] Absolute Strategy Research – Gold losing its shine; November 27, 2020

[iii] FT.com – What does CGT review mean for investors? November 13, 2020

[iv] The Economist – The Spending Review reveals the strains on the Tory party; November 28, 2020

[v] The Economist – What a vaccine means for the America’s economy; November 14, 2020

[vi] Morgan Stanley – Sunday Start; November 22, 2020

 

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By Tom Wickers, Hottinger & Co

Modern Portfolio Theory, created in the 1950s, stressed the importance of diversifying assets to reduce volatility and smooth returns. Government bonds have played a key role in diversification, providing a stable income source as well as the hedging of risk assets. These safe-haven assets perform well in times of market stress, and as such have been one of the best performing asset classes of 2020[i], returning an average of 6.3% Year to Date (YTD). Even one of the best performing indices of the year, the NASDAQ which has returned 32.8%[ii], did not significantly overshadow the 30-year Treasury index which has still registered returns of 20.7% YTD[iii]. However, bond yields have reached all-time lows in the past few months and investors are rightly reassessing whether assets with low or negative yields should still feature in their portfolios.

There have been very few success stories for economies this year. Spending and employment have slumped worldwide, and it is only recently looking like there is an end in sight to the turmoil. Government bond yields have been uncomfortably meagre for the past decade, and in September, the daily rate on a 10-year Treasury yield fell to an all-time low of 0.52%[iv]. Recently yields have edged higher as a result of hopeful vaccine efficacy news and the 10-year Treasury yield has held at 0.85% at the time of writing[v]. Regardless, returns from investing in government bonds look likely to disappoint for the foreseeable future. Real yields are flat at best and the German bund nominal yield appears to be firmly cemented in negative territory. It is clear that government bonds no longer provide a substantial and stable source of income but there are still two enduring justifications for holding them.

Gilts and Treasuries continue to provide a hedge in recessions

Ever since inflation stabilised at lower levels in the 1990s, one of the most attractive qualities of these ‘risk-free’ assets has been the largely uncorrelated returns to equity markets and the tendency to appreciate in recessions when equities were at their worst. When funds need to be moved or withdrawn during a recession, the offset that government bonds provide to portfolios is extremely valuable. Equity prices can remain suppressed for years and dampening the effects of market shocks remains an attractive quality for portfolios with any level of intolerance to risk. J.P. Morgan conducted a study on the performance of government bonds in the COVID-19 market slump in Q1 this year[vi]. They found the appreciation in positive-yielding bonds offset a significant proportion of the equity market’s negative performance [Figure 1]. In fact, the 10-year US Treasury provided a similar level of hedging potential to portfolios as it did back in the 2000s. Conversely and concerningly, negative-yielding government bonds, such as the German bund, offered very little offset to the equity market drop. Many analysts believe yields can only drop so far and that there is a lower bound where investors look elsewhere to store their cash. It is suggested the non-hedging behaviour of the bonds with negative rates is a reflection of being closer to that lower bound.

There is no direct alternative

Government bonds offer security, hedging and liquidity. Unfortunately, no other asset offers these qualities to the same levels. A government bond is described as risk-free because there would need to be almost inconceivable levels of economic stress for developed country governments to default on their borrowings. Although governments are currently borrowing at unprecedented levels, there is still very little concern over default within the G12 countries. The guaranteed capital return of these fixed-expiry securities is unmatched by other offerings. Cash held in a UK bank account is only provided protection of up to £85,000 through the Financial Services Compensation Scheme (FSCS) in the event of default and offers a lower yield. More secure cash depositories are costly and explain why bond holders are willing to accept a negative yield on their investments.

With regards to hedging, many investors have turned to alternatives to provide higher yields as well as downside protection. The traditional 60/40 portfolio (60% equity, 40% bonds) has been augmented over the years to include property, commodities and other alternative investment funds. Absolute return funds aim to provide a constant income regardless of the economic environment and gold has been known to rally much like Treasuries in a market crash. These assets offer further diversification to portfolios and are a rational alternative when partially allocating away from government bonds. There has been widespread interest across the industry and the assets under management are predicted to hold level this year at $10.74tn in defiance of the weaker market[viii]. Despite the enthusiasm for alternatives, investments in government bonds have stood strong. The bottom-line is that government bonds behave in a unique and desirable way. To provide but a few examples of how alternatives do not fill the same shoes; gold is highly volatile and does not offer the guaranteed return that bonds do at expiry; alternatives can use hedging through derivatives on the downside but at the cost of considerable illiquidity or expense; some alternative funds have appreciated in crises, much like government bonds, but often this feels like picking a needle out of a haystack.

Over the next economic cycle, holding government bonds could prove a drag to portfolio performance figures. As economies recover and interest rates creep upward, government bonds will depreciate, and returns may enter the red. If inflation were to return to markets, and the argument for it is noteworthy, bond performance would be hampered further. Yields would push higher to remain consistent on real-terms and bond values would deteriorate. Nevertheless, caution should be taken before insinuating that yields and interest rates can only go up. Many investors have lost out by following this mantra in recent years. Furthermore, it is never known when a negative shock might hit the economy, at which point government bonds prove their worth. There is sufficient justification for investment managers to look elsewhere for income, but for now, while at positive yields, government bonds will continue to be a core holding in almost all portfolios. That said, should Treasury yields turn negative in the future, the game may change entirely.

 

[i] https://www.blackrock.com/corporate/insights/blackrock-investment-institute/interactive-charts/return-map

[ii] Date of writing: 19/11/2020 (https://www.bloomberg.com/quote/CCMP:IND)

[iii] https://www.spglobal.com/spdji/en/indices/fixed-income/sp-us-treasury-bond-current-30-year-index/#overview

[iv] https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yieldYear&year=2020

[v] http://www.worldgovernmentbonds.com

[vi] https://www.jpmorgan.com/securities/insights/do-bonds-still-provide-what-investors-need

[vii] https://www.jpmorgan.com/securities/insights/do-bonds-still-provide-what-investors-need

[viii] https://www.preqin.com/Portals/0/Documents/About/press-release/2020/Nov/FoA-AUM-Nov-20.pdf?ver=2020-11-09-134721-620

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plan it

By Tim Sharp, Hottinger & Co

By the end of October financial markets in Europe and the US were back under pressure as the second wave of COVID-19 gathered pace and the threat of a Democratic “blue wave” unnerved investors. Europe and the UK were already re-introducing lockdowns and infections in the US were rising significantly. This led to the reversal of the reflation trade where long duration bond yields tightened again and commodity prices weakened once more, while the dollar remained broadly unchanged.

The closing of economies led to many government stimulus plans being extended in Europe and increased anticipation that the recovery would be checked in the fourth quarter despite positive third quarter earnings surprises in both Europe and the US[i]. The outcome of the US Presidential election may still be open to question in some quarters but for markets the existing situation did lead to a relief rally as results would indicate that the Republicans would hold the Senate, the Democrats the House on a reduced majority, and Joe Biden became the President – Elect. This drastically reduced the likelihood of major policy changes being agreed, leading to greater certainty for markets, although President Trump is yet to concede office.

However, everything changed last Monday with the announcement by Pfizer / BioNTech that their potential COVID vaccine, in third phase trials, had produced results suggesting 90% efficacy. Very few experts had imagined such a strong outcome and, although the trials are ongoing, it led markets to think about pricing in a time frame for the re-opening of economies. After much contemplation as to the shape of the global recovery many commentators had settled on the K-shaped recovery with the beneficiaries, or those unaffected by the effects of the pandemic, showing strong results while the clear losers from social distancing protocols continued to be supported by fiscal stimulus[ii]. Many citizens are longing for an opportunity to return to normal and investors are no different using the information to instigate another attempt at a rotation in sectors from growth stocks into value stocks.

The strength of the rally we have experienced would suggest a number of technical aspects have also been in play. Many of the stocks that recovered the most were also the stocks carrying the highest levels of short sellers, as well as sectors that have been most damaged by the pandemic[iii]. The reversal in momentum suggests that the switch underway into sectors that will benefit from re-opening may last and the confidence regarding the sustainability of earnings over 2021 has increased. Furthermore, the vaccine uses the same mRNA technology as other vaccines in late stage trials, such as Moderna, Oxford / Astra Zeneca, and Sputnik, which suggests that those trials may provide similar results, increasing the potential for increased doses and a shorter perceived timeline back to normality.

As markets await a post-election fiscal lifeline for struggling sectors, many bond market analysts began to refer to the vaccine as further stimulus for ailing economies with a further rotation back to the reflation toolbox[iv]. It is our opinion that the shape of sovereign yield curves could hold the key for further gains in risk assets as long duration government bonds consider the inflation threat once more, with short term interest rates firmly anchored at close to zero by central bankers. We believe the steepening yield curve is one of the keys to unlocking bank revenues through a revival in net interest margin, and it is no surprise that European and US bank shares saw strong gains during this reflation rally. The potential for European economies to recover is seen by many as heavily related to the fortunes of the banking sector which is still the provider of the majority of corporate funding.

Furthermore, it is our opinion that the relative value of long duration government bonds will have a significant effect on the ability of risk assets to rally further from current levels when historical valuations are still so expensive. When yield curves are flat, as they have been over the last few quarters, we believe that the relative value of equities keeps investors active, leading to acronyms such as the TINA trade (There Is No Alternative). Conversely, when yields start to rise to compensate for the perceived threat of inflation, equities start to look less attractive on a relative basis. The re-pricing of the reflation trade has been a multi-asset event affecting equities, bonds, precious metals, basic commodities and the future direction of the dollar.

The future path of the US dollar could have a material effect on the flow of money into riskier assets and regions. If the final effect of the reflation trade is a weaker dollar then historically this would point to increased investment into emerging markets, and could also take the pressure off the dollar debt burdens of many emerging countries, thereby increasing the attractiveness of emerging market debt as an alternative to high yield, where debt burdens are still worrisome in our opinion.

We believe the vaccine news gives rise to increased optimism towards the re-opening trade allowing stagnant areas of the economy to recover, which favours value stocks. This may shorten the bridge that unprecedented levels of fiscal stimulus have to build on the road back to normality. However, it could also bring forward inflation concerns which may challenge the central bank’s stipulation that rates will stay lower for longer and threaten the relative valuation of equities, which could change the investment thesis of the recovery so far.

 

[i] ASR – Investment Committee Briefing – November 2, 2020

 

[ii] https://www.bloomberg.com/opinion/articles/2020-09-02/the-k-shaped-recovery-is-real-and-it-perfectly-captures-the-economy

 

[iii] ASR – Quantitative Strategy – November 11, 2020

 

[iv] https://www.ft.com/content/48b41db0-24de-4bff-a58d-1f26963d8bcc

plan it

By Tim Sharp, Hottinger & Co

As the UK settles down to 4 more weeks of national lockdown, we thought it might be timely to look to the future. This pandemic unlike others, will undoubtedly leave long-term scarring on the world but how deep is yet unknown.

What we do know is that after 10 months or so we can look back and confirm that the world was not equipped well enough to cope with a pandemic. So far it appears recorded deaths have reached 1.1m worldwide primarily among the elderly. It has also been interesting to observe how some countries have managed the disease better than others. What is clear is that Covid-19 has inflicted a huge global recession, but again not one that has been equal across countries.

The fiscal expansion could reach 10-15% of GDP in 2020[i]. We could see fiscal dominance become a permanent feature, with lower interest rates for longer leading to higher inflation, something most companies may now be happy to live with…..long gone perhaps are the days of trying to manage to a 2% inflationary target. Mr Osbourne will no doubt choke on his cornflakes, but with the backdrop of increased interventions over the past 10 years the inflationary target has become somewhat irrelevant in our opinion.

The economic damage inflicted looks to have had a profound effect on the young, the relatively unskilled, working parents, and vulnerable minorities. We know social distancing, enforced or otherwise, has damaged all close proximity activities. Travel has been decimated. A high proportion of businesses will be carrying much more debt and because of it many could well fail. Central bank intervention in peace times has been unprecedented across all major currency countries.

Political tensions both domestically and internationally has been heightened as the blame game has begun and has called into question the merits of globalisation when supply chains have been greatly challenged. With this backdrop what could the longer-term look like?

Recent optimistic news announced by Pfizer points to a slightly sooner than expected roll out of an effective vaccine globally, but we along with many others, caution about becoming too expectant in the short term meaning the disease will remain a threat for longer, and we are still going to have to learn how to live with it.

So, what will be the new structure of economies if we must learn to live with it for longer? Will things just go back to the way they were pre-Covid 19, or, will we stop travelling and commuting to work for good? We believe commuting will start again, but it has been proven that many industries can cope with both, so it is likely businesses will look to make efficiencies and the demand for large office footprints will decline. This pattern of virtual engagement will continue, it is here to stay, some industries adopting it more than others, which in-turn will change some patterns of living and working forever.

Technology has been an obvious winner, but perhaps the reliance on tech and the central role they have played has also accelerated the thought process that the reliance on them, and the influence they have is unnerving, and may need to have tighter regulation. We would expect tighter regulation and increased competition to put pressure on the sector in the short term, but we still remain optimistic for the sector long term.

Another obvious winner on a global scale has been China. Whilst most developed markets will struggle to get back to pre-COVID levels, China has managed to grow its economy by circa 10%[ii]. The US has responded, trade disputes will not be resolved quickly, and how this Sino-US economic relationship plays out will have a profound effect on the rest of the world. Whilst China has been a winner, it is our opinion that some emerging markets will be left with scarring so deep that they return to a period 20 to 30 years ago, where income levels had no chance of converging to developed market levels. Places such as South Africa have reportedly seen unemployment levels rise to 50% during the pandemic, and the chance of higher default is rising as some emerging markets take on debt to invest their way out of trouble.

Demagogue populist leaders, Bolsonaro, Johnson and Trump have not fared well, in our opinion, and this perhaps will lead to a shift away from their performance politics, subject to there being a credible alternative.

Finally, Covid-19 has highlighted strengths and weaknesses around common purpose. The world has challenged itself to do things better, Miss Thunberg will be pleased to see climate is still very high on the world agenda. President Xiu recently announced China will achieve peak emissions in 2030 and has set the goal of being carbon neutral by 2060. For the world’s largest pollutant economy, this is good news. Yet we have also seen a weakening in the legitimacy of international agreements, namely the US’s withdrawal from the Paris Climate Accord and the World Health Organisation.

In summary Covid-19 has slammed on the world’s brakes, and we have suffered a global whiplash. It is sure to have created long and profound consequences for business, the economy, politics and international relations. Change is inevitable, some we can predict and some we are yet to learn.

[i] Source: ASR Economics Weekly – 5 ways Covid-19 has changed the World – 5/11/2020

[ii] Source: ASR Economics Weekly – 5 ways Covid-19 has changed the World – 5/11/2020

Resource: FT World Economy 3/11/2020

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plan it

 

plan it

By Tim Sharp, Hottinger & Co

Equity markets started October in buoyant fashion as retail investors, mutual funds and hedge funds alike put cash to work and bought the September dip. Yet, by month-end western markets were under pressure again as the second wave of the pandemic rolled across much of Europe. In the US, investors were concerned about the deadlock in stimulus talks and seemed less sure than the pollsters that a Biden-led “blue wave” would prevail. In the UK, Boris Johnson marked Halloween, a Celtic festival often associated with something more sinister than the beginning of winter, to announce a mutation of the March lockdown.

The initial positive sentiment in the US was driven by expectations that a Democratic sweep in the forthcoming election would lead to greater fiscal stimulus, and a belief that the US Federal Reserve would tolerate higher inflation before tightening. Meanwhile, with Q3 earnings season on the horizon, there was the usual opportunity for companies to beat carefully managed expectations.

In Europe, the central bank was expected to do more to support the recovery with additional asset purchases, probably under the Pandemic Emergency Purchase Programme. While, in the UK, there were signs that the Bank of England would loosen policy further after it asked the banks to provide information regarding their ability to implement negative rates without damaging their businesses.

Chinese markets were closed during the first week of October due to a lengthy national holiday but reopened to strong investor demand assisted by positive economic data. The Caixin China General Purchasing Managers’ Index showed activity climbed to its highest level in three months in September, while GDP expanded by almost 5% year-on-year; China could be the only major economy to record positive growth in 2020. By mid-month the total value of China’s stock market had risen to a record high of more than $10tn, thereby surpassing its previous peak of five years prior [i]. Ant Group dominated investor attention towards the end of the month as it became the largest initial public offering in global financial history breaking records in Shanghai and Hong Kong. It attracted orders of more than US$3 trillion (equal to the GDP of the UK) and was oversubscribed by almost 400 times, according to the South China Morning Post.

Demand for Chinese assets was not solely confined to the equity market; the renminbi traded at its highest level against the US dollar in over a year, despite the Chinese central bank lowering the cost of betting against its currency. In the bond market, Beijing received strong demand selling dollar debt directly to US buyers attracted by the superior yields versus US Treasuries.

The positivity surrounding Chinese assets helped the country’s equity market remain in positive territory for the month where other major markets failed, following a brutal final week in which fear surrounding the pandemic returned to markets.

The resurgence of the virus has been seen across Europe in particular, with national lockdowns in France and Germany, alongside local lockdowns in the UK. The US has remained open but with a record number of cases being reported, whilst Asia remains less affected at present. This sliding scale of severity was reflected in the performance of global equity markets over the month, with China and emerging markets gaining 2%, the S&P500 losing 3%, the FTSE100 giving up 5% and the Euro Stoxx 50 down 8%.

The equity market sell-off in the final week masked a broadly positive earnings season in both the US and Europe. Earnings beats across the two regions reached the highest level since 2009. Positive surprises were generally higher among cyclical stocks but there was earnings growth among the Defensives as well [ii]. Further, most companies reported an improved outlook based on a better-than-expected recovery during the past quarter. In addition, some companies expressed plans to reinstate their dividends, including HSBC, Credit Suisse and Royal Dutch Shell. However, within the technology sector the strong gains recorded so far this year brought high expectations, and companies including Apple, Intel, SAP and Twitter received a rude awakening when either, missing earnings, or simply not providing positive guidance.

For a second consecutive month, government bonds failed to act as an effective hedge against falling stock markets, with the US and UK 10-year yields rising by 19bp to 0.87% and 3bp to 0.26%, respectively. In the US, the long-end of the yield curve has been driven higher by expectations of a Democratic sweep that could usher in significantly more stimulus to support the economy, thereby pushing up inflation expectations and bond yields with them. The economic data has also been supportive of higher yields; the US economy expanded in the third quarter at its fastest pace in  post-war history as activity bounced back from Covid lockdowns.

The Gilt market was dealt a blow by Moody’s, which cut its investment rating one notch to Aa3 – equivalent to a double-A minus rating from rival S&P Global. The agency said it believed growth would be “meaningfully weaker” than it had previously forecast, and that the economy had been struggling even before the pandemic took hold [iii]. Certainly, the economic data during October backed-up Moody’s pessimism. The economy grew by a disappointing 2.1% in August and remains 9.2% below pre-pandemic levels in January. Meanwhile, consumer confidence, spending and mobility dropped in October while the number of people claiming out of work benefit has doubled from its level in March.

In commodity markets, gold fell marginally to $1,878 oz, thereby also failing to hedge against equity market volatility while Brent crude fell 11% to $37 a barrel in response to the expected hit to future demand from further lockdowns.

It is fair to conclude that markets ended October in a sombre mood and November is teed-up to be a pivotal month with ongoing Brexit negotiations and the US going to the polls. Yet, whilst the US election might be a source of further volatility in the short-term, especially if it is too close to call on the night, over the long-term elections typically have little impact on market performance, and a decisive outcome would remove a source of risk. Of greater importance could be any developments with regards to a coronavirus vaccine and, according to the biotech and pharma research team at Neuberger Berman, there could be some market-market-moving news on the horizon. They believe that both Pfizer and Moderna could potentially apply for emergency use authorisation (EUA) for their vaccines by late November/early December. Of course, “there’s many a slip ‘twixt the cup and the lip” but markets may not be pricing-in too much good news at present.

[i] ft.com – China’s stock market value hits record high of more than $10tn; October 14, 2020

[ii] Barclays – Lockdown 2.0 and final countdown to the election; October 30, 2020

[iii] ft.com – UK credit rating downgraded by Moody’s; October 17, 2020

[iv] Neuberger Berman – Moving the needle; October 26, 2020

 

 

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plan it

plan it

 

plan it

By Laura Catterson, Hottinger & Co

We are a week out from the US presidential election and focus is on the electoral college.

When Americans cast their ballots for the US president, they are actually voting for a representative of that candidate’s party, known as an elector. Each state has a different number of electors based on the number of congressional districts they have plus two additional votes representing the state’s senate seats.[i] There are 538 electors up for grabs with 270 needed to win the presidency.

Most news outlets are positing that Biden is favourite with national and state polling showing that he has more pathways to 270 electoral votes than Trump.[iii] For Trump to clinch a second term, he will need to win a number of states where Biden is currently leading. These so called, “swing states”, are where the election is really decided.

If Biden wins these swing states with a considerable margin, he will be able to brush off any attempt by Republicans who challenge the results. However, if the margin is much closer, expect recounts, legal challenges, and a tense few days, weeks or even months. Thus, the electoral college map, and math, are very important.

There are fourteen states and two congressional districts which both campaigns are paying very close attention to. They can be grouped as follows:

The six swing states: Michigan, Wisconsin, Pennsylvania, Arizona, Florida and North Carolina

To understand the importance of these states, you need look no further than a recent NPR news report which shows that the Biden campaign and supporting groups have spent almost 90% of their money there, while Trump and Republican organisations have spent 78 cents of every dollar across the six.[iv] They hold such weight during each election due to their relatively even political divide, size and voting history. President Barack Obama won Michigan, Wisconsin, Pennsylvania and Florida in 2012 however, so did President Trump in 2016. North Carolina voted for Obama in 2008 but went Republican in 2012 and 2016. Arizona has notoriously voted Republican for decades and yet has been trending Democratic in recent years. Even a small victory in any of these swing states can have a huge impact on the overall result. In 2016, Trump won all six, three of which by less than a percentage point.

Florida (29 Electoral Votes [EVs]) and North Carolina (15EVs) are notoriously red-leaning however, Biden is currently leading in both,[v] albeit by a very small marginal average of one to three points.[vi] Michigan (16EVs) and Wisconsin (10EVs) typically turn blue and this year they appear to be following suit with Biden enjoying average nine[vii] and seven[viii] point leads respectively. Pennsylvania (20EVs) and Arizona (11EVs) are in the middle, yet Biden also leads both states with five[ix] and three[x] point advantages.

If these polls come to fruition, Biden looks set to win the presidency. If the race tightens, the margins in these six states are crucial.

Across all six, 101 electoral votes are on offer; of which Biden needs 38 – assuming all other states that typically vote Democrat do so. Following the same logic, Trump needs 66. Trump must win Florida and three others to reach this number. Biden, however, could reach 38 by winning Florida and just one of the other five states. Even if Biden loses Florida, he could also secure victory by winning Wisconsin, Michigan and Pennsylvania.

The two swing congressional districts: Nebraska’s second district and Maine’s second district

Maine and Nebraska diverge from tradition by allotting some of their electoral votes to the winners in each congressional district rather than the state-wide winner. Realistically, one of Maine’s two districts is safe for Democrats, and two out of Nebraska’s three districts are safe for Republicans. The remaining district in each state — Maine’s Second District (1EV) and Nebraska’s Second District (1EV) — is up for grabs. Crucially, these districts will only come into play if the race is neck and neck. One such scenario is if Biden wins Michigan and Pennsylvania while Trump takes Wisconsin, Florida, North Carolina and Arizona. As it stands, Biden leads by two[xi] points in Maine’s second district and seven points in Nebraska’s second district.[xii]

The states Trump is trying to defend: Ohio, Iowa, Georgia and Texas

Within these four states, Biden hopes for an upset. He is trying to win the traditional swing states of Ohio (18EVs) and Iowa (6EVs), both of which went with Obama twice but voted heavily for Trump in 2016. Current polling shows the candidates are pretty much tied[xiii] in each state.[xiv]

Texas (38EVs) and Georgia (16s) on the other hand, have not voted Democrat in decades. The margins, however, are shrinking. Trump is narrowly ahead in Georgia[xv] and on average three points up in Texas.[xvi] It would indicate a massive upset should these states flip.

The states Biden is trying to defend: Nevada, New Hampshire, Minnesota and Maine

Not to be taken for granted by the Democrats are Nevada, Minnesota, New Hampshire and Maine. Polling in Nevada and Minnesota shows Biden up by seven[xvii] and six[xviii] points respectively. Although Trump could make up some ground here, they are less likely to be as decisive as the main six swing states, hence there is some understandable optimism in the Democratic camp.

New Hampshire (4EVs) and Maine (2EVs) are far less competitive with polls showing Biden in double digits[xix] for both.[xx]

President Trump’s paths to 270 electoral votes are far more limited than Biden’s. As it stands, Trump’s prospects depend on late and fundamental shifts in the dynamics of the race. With both debates over and no consequential shift in the polls, re-election is looking tough. President Trump has proved himself however, as a candidate not to be underestimated. This race is far from decided and all eyes will be on the electoral map come 3rd November.

 

*Please note all polling stats were accurate at the time of writing.

[i] https://www.theguardian.com/us-news/ng-interactive/2020/oct/24/electoral-college-explained-biden-uphill-battle-us-election

[ii] https://ig.ft.com/us-election-2020/

[iii] https://edition.cnn.com/2020/10/25/politics/paths-to-270-analysis/index.html

[iv] https://www.npr.org/2020/09/15/912663101/biden-is-outspending-trump-on-tv-and-just-6-states-are-the-focus-of-the-campaign

[v] https://www.realclearpolitics.com/epolls/2020/president/nc/north_carolina_trump_vs_biden-6744.html

[vi] https://projects.fivethirtyeight.com/polls/president-general/north-carolina/

[vii] https://www.realclearpolitics.com/epolls/2020/president/mi/michigan_trump_vs_biden-6761.html

[viii] https://projects.fivethirtyeight.com/polls/president-general/wisconsin/

[ix] https://www.realclearpolitics.com/epolls/2020/president/pa/pennsylvania_trump_vs_biden-6861.html

[x] https://projects.fivethirtyeight.com/polls/president-general/arizona/

[xi] https://projects.fivethirtyeight.com/polls/president-general/maine/2/

[xii] https://projects.fivethirtyeight.com/polls/president-general/nebraska/2/

[xiii] https://www.realclearpolitics.com/epolls/2020/president/oh/ohio_trump_vs_biden-6765.html

[xiv] https://www.realclearpolitics.com/epolls/2020/president/ia/iowa_trump_vs_biden-6787.html

[xv] https://www.realclearpolitics.com/epolls/2020/president/ga/georgia_trump_vs_biden-6974.html

[xvi] https://www.realclearpolitics.com/epolls/2020/president/tx/texas_trump_vs_biden-6818.html

[xvii] https://projects.fivethirtyeight.com/polls/president-general/nevada/

[xviii] https://www.realclearpolitics.com/epolls/2020/president/mn/minnesota_trump_vs_biden-6966.html

[xix] https://www.realclearpolitics.com/epolls/2020/president/nh/new_hampshire_trump_vs_biden-6779.html

[xx] https://projects.fivethirtyeight.com/polls/president-general/maine/

 

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plan it

By Tim Sharp, Hottinger & Co

Across developed countries there are signs that the recovery is slowing and the evidence of a second wave of the COVID-19 virus is likely to check the return to normal. September flash PMIs mostly held above the important 50 expansion figure, however, Services PMIs declined, especially in Europe where the reading fell into contractionary territory under pressure from growing new cases. Conversely, China seems to have weathered its own second wave quite well with statistics suggesting that domestic flights have returned to pre-COVID levels and consumer confidence seems to be growing[i]. The National Bureau of Statistics announced third quarter GDP grew 4.9% year-on-year and retail sales in September were up 3.3% from a year earlier. China is expected to be the only major economy to post positive growth in 2020 which could be good news for other countries in the region.

Although demand for capital goods continues to support the global recovery it is unlikely, in our opinion, that this can be sustained in the fourth quarter as fiscal stimulus is reduced and employment comes under pressure. The recovery has been uneven across countries and although the demand for goods and residential housing has been strong, the services sector remains severely depressed. There is a limit to how far the consumption of goods can substitute for lost consumption of services and the momentum looks likely to slow into the fourth quarter. Activity should start to level out after the post-lockdown bounce as localised lockdowns are introduced to help combat a second wave and the US Presidential election in November adds to uncertainty.

We believe the fundamental outlook for growth and earnings will be challenging for risk assets and, although valuations eased over the past month, growth stocks still hold historically lofty valuations and traditional value sectors remain in deep value territory. The equity rally has become increasingly concentrated, with Technology stocks the clear beneficiaries, while the stocks and sectors most affected by the pandemic are still significantly lower than pre-crisis levels. There have been attempts to rotate into undervalued assets during the recovery but the growing fears over the spread of new cases means such moves have not been sustained. However, it is difficult to see past equities as an investor with so many asset classes on stretched valuations. We continue to favour a cautious approach to equities based on valuation, cash flow, and the ability to navigate a changing landscape.

The level of support offered by government bonds in an environment of weaker equity prices has been somewhat compromised due to low yields. The extra premium offered by corporate bonds may therefore seem attractive even though they are historically tight. The US corporate bond markets have been supported by Fed purchases which have kept certain borrowers from default. However, the US High yield trailing 12m default rate was above 6% in August[ii], with speculation that it will move significantly higher over the next nine months as the recovery slows. It is our opinion that this plausible increase in the default rate is not properly priced into credit markets.

Some are calling this a K-shaped recovery because while there have been some spectacular winners equally there have been clear losers. We see that the hospitality sector is struggling to cope with social distancing and the industry employs many young people on lower incomes who have relied on government support to survive. Therefore, as emergency fiscal support is withdrawn, we would expect to see a score of people, who are currently listed as temporarily unemployed or on furlough, transition to full unemployment during the fourth quarter with its inevitable effect on growth.

It is difficult to see how the service industry will be able to recover under social distancing measures until a vaccine can be approved and mass-produced, but the efficiency of the vaccine will also affect the return of consumption to pre-COVID levels. With two frontline trials being temporarily suspended this week the path to approval remains as uncertain as always, but market sentiment seems to remain linked to vaccine news flow.

The full extent of economic scarring may become more evident as fiscal stimulus is tightened, negotiations between Republicans and Democrats seem to have hit an impasse that is unlikely to see a new US package agreed before the Presidential election. The markets are likely to remain volatile in the run up to the election with further anxiety over the possibility of a contested result. In our opinion the market has priced in a Biden win and Democrat “sweep”, which would be less likely to be contested, and the likely larger fiscal stimulus injection. This result would add further support to risk assets as it seems to us that a Trump victory would now see an adverse reaction by equity markets.

September was touted as a decisive month for Brexit and an EU trade deal because both sides have previously stated that any deal would have to be finalised by mid-October. However, little progress has been made and the issues surrounding fishing waters and fair competition policies remain unresolved. We have increased the risk of the UK leaving without a deal to high. Even if a deal can be struck, we expect the result to be minimalist providing little support to businesses, leaving the UK economy to suffer under significant levels of uncertainty.

Finally, the Fed’s move to average inflation targeting has substantially increased the inflation risk premium in markets even if the expected slowdown in the fourth quarter reduces the pricing pressures within real economies. We continue to favour the defensive qualities of commodities as one of the only asset classes to benefit from inflation. The recent dollar weakness has favoured emerging market equities particularly in countries that benefit from rising commodity prices. However, more recently the dollar’s safe haven qualities have seen it strengthen and the expected slowdown in the recovery will place pressure on emerging markets once more.

 

[i] Barclays Global Outlook – Glass Half Full – 24th September 2020

[ii] Absolute Strategy Research – Investment Committee Briefing for October – 02/10/2020

plan it

By Tom Wickers, Hottinger Investment Management 

The Coronavirus crisis continues, tech took a tumble and perturbing party politics are three appealingly alliterate headlines that summarise the majority of September’s economic news. The month kicked off with a bang as the tech sector had a shake down that many saw as inevitable. Several stocks were heavily hit, Tesla fell 34 % and the NASDAQ fell 10% over the course of a week. American indices, which are notably tech-heavy, recovered somewhat but still ended the month in the red and the S&P 500 index was down 4% over September.

Big tech valuations have been noted as high for months by many investment houses and while many other analysts believe the prices to be justified, a spook in the form of Softbank was enough to instigate a sell-off. Softbank was found to have become very involved in the Big Tech call options market in an investigation conducted by the Financial Times at the start of September[i]. The private equity firm appeared to transform into a quasi-hedge fund following a strong move into public markets. The revelation worried investors  as well as Softbank’s shareholders, analysts re-evaluated whether the tech sector had grown too hot, resulting in a sharp drop in prices.

Softbank has also featured in other news as it looked to sell its holding in Arm to NVIDIA. The UK chipmaker was long called a ‘crystal ball’ for investment research into the technology sector by Masayoshi Son, Softbank’s CEO. The clear change of focus by Softbank was originally received poorly by investors, however the share price recovered to end the month down just 2%. Should NVIDIA’s acquisition be approved by authorities, the merged entity would be a powerhouse in both artificial intelligence and computer microchips and would become a formidable player in the technology sector. In UK markets, HSBC received a rare bit of good news. The Eurasian bank, which has found itself in difficult financial and political waters this year, was heavily financially backed by Ping An Asset Management, one of its largest investors, on Monday[ii]. The share price rocketed 10% but was still down 49% year-to-date at the end of September. Incidentally the banking sector saw the largest decline of the month, down 7%, in contrast to the 4% experienced in the technology sector[iii].

A second wave of infections well and truly took hold in Europe. Spain instigated fears of a second wave back in July, and since then we have seen resurgences of new cases in France, Russia and most recently the UK. Earlier this week a sobering milestone of 1 million deaths was passed, with no end in sight for the pandemic. To add insult to injury for the markets, just this morning it has been announced that Donald Trump has contracted the virus, putting him and his family in isolation. The southern hemisphere and the USA battled to keep down infection rates while we enjoyed our summer, but an increase in the R number infection rate in multiple areas in Europe has raised concerns over the longevity of any economic recovery. Coupled with technology sector woes, global markets were left down 3.6% in September[iv]. Investors and households alike are keeping a keen eye on progress in vaccines, which are still thought to be the primary hope for the rejuvenation of societal norms. Johnson & Johnson’s product became the fourth global vaccine to enter Phase 3 of trials, meaning progress remains positive. Unfortunately, any realistic timeline for a vaccine is still protracted and mass vaccination is not forecast to occur until at least the second half of next year[v].

The UK was unable to cope with COVID-19 when it first reached our shores in March and has demonstrated similar incapabilities at containing this second surge. A 7-day moving average of new cases in the UK shows that authorities are reporting roughly 1,500 more daily cases than in the previous peak in May[vi]. Our healthcare system processes three times as many PCR tests as in May, meaning we are not yet at previous infection levels. However, on an exponential curve it will not be long. Boris Johnson has released a statement to say the UK is at a ‘critical moment’ with the Coronavirus[vii] and the ONS and Imperial College’s REACT have issued conflicting reports as to whether the R number is increasing or decreasing[viii]. The next few weeks will prove pivotal for the UK economic recovery.

September was touted as a decisive month for Brexit and an EU trade deal, both sides have previously stated that any deal would have to be finalised by mid-October. Little progress has been made and the large issues surrounding fishing waters and fair competition policies remain unresolved. The government has begun proceedings to renege on the withdrawal agreement made last year and the EU responded yesterday by initiated legal proceedings[ix]. To say that a Brexit deal appears unlikely is no overstatement at this stage.

The UK flash composite PMI figure came in lower than the August level at 55.7, which has continued the trend of a slowdown in economic recoveries in developed economies. The US flash composite fell slightly to 54.4, demonstrating slower expansion and the Eurozone’s figures were as low at 50.1, suggesting no growth. Last week, Rishi Sunak, the Chancellor, announced a Job Support Scheme stimulus package to combat the recent sour economic news[x], however the outlook for our economy continues to look grey at best.

The American election race began in earnest on Tuesday as Donald Trump and Joe Biden had their first public debate. It is safe to say that neither candidate impressed, both resorting to jibes instead of addressing political matters directly. Joe Biden is still thought to be favoured by 10% more voters than Donald Trump but there is sufficient uncertainty over majorities in swing states that Trump could still surprise on the 3^rd November. The US economy showed some promising signs of growth as consumer spending rose 1.0% in August. On the flip side of the coin, incomes fell by 2.7% in the same month which could be a headwind for continued growth in the coming months. The next US stimulus package continues to be the subject of much speculation. Monetary and fiscal policies have underpinned markets since the crash in February and have proved a critical component of many short-term investment decisions in 2020. The Fed has already set expectations of near-zero interest rates through to 2023[xi]and has flooded the market with quantitative easing, leaving eyes predominantly fixed on fiscal stimulus. Democrats and Republicans are yet to agree on how large the relief should be and what it should be spent on, however, Democrats have recently proposed a $2.2trn package and investors are hopeful that it will be passed soon[xii], leaving the S&P 500 up 4.1% in the last week.

China’s economy has surprised investors with its resilience to the crisis since the beginning of the summer. By March, China had reduced its infection rate to near zero and has not yet seen a rebound in numbers. The result is that the manufacturing sector has been effectively fully restored, powering GDP growth. The Economist estimates that China is on track to hit annual growth of 5% in Q3, compared to 6% the previous year[xiii], making the crisis more of a stutter for development rather than the catastrophe other economies are experiencing.

At the end of August, the Fed issued a statement outlining its views on its inflation mandate. The central bank emphasised its plan to target average inflation. As mentioned in our strategy blog this month, JP Morgan Asset Management have pointed out that between 1994 and 2020, US average Core PCE only exceeded 2% over a three-year period[xiv]. This begs the question of how hot the economy will be allowed to burn. The key topic for economic analysis in September has therefore been whether we should expect inflation or deflation next year and going forward. Low economic activity resulting from the Coronavirus crisis clearly poses a headwind to the return of inflation, but on the upside, dovish central bank policies, incredible injections of money supply and deglobalisation all make the picture more believable. Whether it appears that inflation will feed through or whether economies suffer from Japanification will have significant implications for the positioning of portfolios and we expect to see the debate continue into the new year.

 

[i] https://www.ft.com/content/75587aa6-1f1f-4e9d-b334-3ff866753fa2

[ii] https://www.ft.com/content/5f6ca31f-310b-45e6-97fa-1db3bbcc8849

[iii] Absolute Strategy Research – Investment Committee Briefing 02/10/20

[iv] MSCI World figures https://uk.investing.com/indices/msci-world-historical-data

[v] https://www.cnbc.com/2020/09/15/there-may-not-be-enough-coronavirus-vaccine-doses-to-quickly-supply-the-world-gates-foundation-says.html

[vi] https://www.worldometers.info/coronavirus/country/uk/

[vii] https://www.bbc.co.uk/news/uk-54362900

[viii] https://www.bbc.co.uk/news/54296475

https://www.imperial.ac.uk/news/205473/latest-react-findings-show-high-number/

[ix] https://www.bbc.co.uk/news/uk-politics-54370226

[x] https://www.bbc.co.uk/news/business-54280966

[xi] https://www.nytimes.com/2020/09/16/business/economy/federal-reserve-interest-rates.html

[xii] https://www.ft.com/content/a7dd4408-2072-4e6e-b563-ded272a9ed35

[xiii] https://www.economist.com/finance-and-economics/2020/09/19/what-is-fuelling-chinas-economic-recovery

[xiv] Market Watch webinar held by Karen Ward and Myles Bradshaw on the 16^th September 2020

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By Andrew Butler-Cassar, Hottinger & Co

The banking and wealth management industry has grown over the decades built on trust and long-term relationships, and this traditional approach to people’s financial affairs has stood the test of time. However, with the rise of the machines in many sectors of our day to day lives you might be wondering why Amazon Bank or Google Wealth Management doesn’t exist already?

In this article we will explore what is and will likely be adopted in the wealth management industry in the short term and whilst at Hottinger we don’t speculate, we will finish with what the next gen expects.

Full automation supported by artificial intelligence (AI) has already started to infiltrate our everyday lives, often without us really knowing. Often quoted is the accuracy of healthcare analysis produced by a computer, but who wants an app telling you that you have a life-threatening disease! Whilst the machines can help us mortals deliver better results, we still want those results to be delivered with empathy, a trait the machine hasn’t mastered…..yet! However complicated the problems that take a team of mathematic scientists to answer, with a margin of error, quantum computing can solve. Furthermore,   AI can manage much of the mundane operational functions that are prone to human error. In larger retail banks that service retail customers, AI is now deciphering large amounts of ‘customer behaviour’ using algorithms to promote new products and services; “know your customer” just got a whole lot more mathematical !

Blockchain Technology is already in use in many banking transactions and billions have been invested in systems by some of the largest US institutions. A Santander report published in 2015 shows that banks and property management companies could save up to $20bn a year by late 2022. According to research by Roubini ThoughtLab, 225 out of the 500 wealth management managers it surveyed had incorporated the technology in some way. (1)

Furthermore, blockchain technology is expected to create multiple new classes of assets that  will become easier to own that currently cannot be settled and are subject to abuse. . For example, shares in collectibles and property could be verifiable and part ownership easier to manage and value.

Robo Advisors is an area written about so much already in the wealth sector that it has almost become passé. Many have tried and failed take Investec’s click n invest, or, UBS Smartwealth, millions spent but neither are commercially viable today. However, the sunk cost may not have been all lost. Over the last few years, Tiller Investments, a firm well known  to us, that began life as a robo advisor and white-labelled solution for other advisors, soon came to realise that in fact it was their architecture that they had built around onboarding clients that many other banks and wealth managers were interested in. Like any well run tech firm Tiller Investments understood the importance of the timing of adoption and the need to pivot when necessary. The beauty of the smaller new market entrants is that they do not have to deal with legacy systems and can design their architecture to be open making it easy to plug-in and integrate with current bank systems. The area of onboarding and compliance in general has seen millions spent on employing new staff that, instead, could be well served by new technologies working faster and more efficiently.

But will clients see the benefits of these early adoptions, afterall, none of this sounds like a flashy new portal or higher quality reporting, and is that really want clients want? Clearly faster and more efficient account opening is music to both wealth management firms and the client’s ears alike and the development of better analysis through AI and blockchain may well lead to better client solutions. However, where we have seen the greatest change in a short space of time is in the ability to spend more time with clients!

So what can clients expect from this technological revolution? A better relationship, communication and aggregated reporting appear high on the agenda. What type of relationship does a client want? Adviser led, technology led or a mix, to be determined as and when the client requires it? Clients have faster and more detailed access to their portfolios and multiple formats to contact their wealth manager including by, video conference, on-line chat, email, social media, or the good old fashion telephone. Achieving a full view of net wealth across banking, investments, debts, pensions and more has always been hard but this is changing quickly through changing regulation. “One place”, or, “One bank” are  slogans banded around by bankers and wealth managers who see the value in providing aggregation for ‘free’.

“Clients expect unique, tailor-made services suitable to their individual needs. They value modern, intuitive financial management platforms, available at any time via a phone or a tablet, but they still care for an experienced professional who will translate and explain the strategies proposed by the systems and help in making the decision. They are willing to pay a premium for such a combination of intuitive tools with an experienced personal adviser” says Patrik Spiller, Partner, Wealth Management Industry Lead at Deloitte Switzerland. (2)

And so, to the future. Generation Y, or the millennial, is not as loyal to service industries as Generation X, or Baby Boomer. Younger people would rather visit their dentist than their bank manager! We believe firms need to incorporate technology to be more engaging, instead of a list of boring questions to determine your risk profile, why not an online game? Gamification, already used in the insurance industry, could be one way to improve the dull reputation of wealth management, which often struggles to persuade us that asset allocation is at all interesting. But what us oldies might find even more surprising is that whilst brand loyalty isn’t everything, solid and considered advice along with an advisor making the effort to educate and be visible is still a need for the next generation. The matter of money is still a personal one and whilst that remains the case, people beat machines at the ‘inter-coal-face’ !

References:

1. Richtopia September 2020
2. Deloitte paper 2019: The future of wealth management. What will the financial ecosystem look like in 2030?

Additional Source material:

Raconteur – Four top uses of technology in wealth management – July 2019

 

 

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By Tim Sharp, Hottinger Investment Management 

The pullback in major technology stocks at the beginning of September saw the NASDAQ reach 12,000 before retracing 11% in a week, giving the bulls an opportunity to implement the buy-on-dip strategy prevalent throughout the pandemic period. There is little doubt that “Tech” was expensive, having reached valuations not seen since 2000, so any weakness is healthy for general markets. However, the major questions that will potentially affect the real economy and financial markets going forward are whether the move by the Fed to average inflation targeting will increase the threat of inflation and whether the recent weakness in the dollar will be short-lived or a structural change in direction.

Following the mounting levels of fiscal and monetary stimulus, there is little doubt that the risk of inflation is firmly to the upside and recently, there were signs of a pick-up in inflation in the near term through a rise in US core Personal Consumption Expenditure (PCE) index in July, and US Purchasing Manager’s Indices (PMIs) in August saw input prices strengthen on the higher cost of raw materials. Conversely, the Eurozone core Consumer Price Index (CPI) weakened in August suggesting that inflation is weaker in Europe, and the fall in UK inflation was attributed to the “eat out to help out” scheme pushing down food prices. In the short term, it is unlikely that inflation pressures will build significantly when the future path of the recovery remains uncertain and this is shown by market expectations’ continued downtrend.

During a recent weekly “Market Watch” webinar, Chief EAM Strategist at JPMorgan Asset Management, Karen Ward, and portfolio manager Myles Bradshaw, forecast the effects of the Fed’s new average inflation targeting policy. They pointed out that between 1994 and 2020 US average Core PCE was only over the 2% target for the period of 2004 to 2007, suggesting rates are going to be anchored near zero for the long term if average inflation over 2% is to be achieved. However, a reactivation of fiscal support for economies, a continuation of the global recovery, and increasing central bank tolerance for higher inflation, does suggest that the threat of future inflation may be higher than current market indicators suggest, leaving the risk firmly to the upside. By association, therefore, markets are also susceptible to US 10-year Treasury yields moving back to 2% as opposed to falling into negative territory.

The low level of nominal yields on government bonds does mean that the ability to offset equity risk is diminished despite the negative correlation, and negative real yields mean that there is a cost to the risk-free rate once more. The low default rate in investment grade corporate bonds and the positive sloping yield curve is proving an attraction to investors seeking a real return without the risk of high yield bond investing, which has resulted in yield spreads over Treasuries tightening over the month.

When global growth starts to recover and US real yields fall, the combination often leads to a weaker dollar. The policy choices of whoever enters the White House after the election will be difficult with negative implications for the currency. The positive developments in the Eurozone, namely the establishment recovery fund and the more successful re-openings of its economies, have painted a positive backdrop for the Euro that may put further pressure on the dollar, even allowing for a second wave of the Covid-19 virus. However, long-term weakness in the dollar has its headwinds as foreign demand for the dollar continually exists to execute international trade and the USD continues to hold global safe-haven status as the world’s reserve currency. We have highlighted before that a weak dollar is very beneficial for international growth, particularly in developing economies but this may be more of a strong Euro story than a weak dollar story over the long term.

The UK government has passed the Internal Markets Bill which looks to over-ride parts of the Brexit Withdrawal Agreement at a time when negotiations over the EU-UK trade agreement were set to re-start. This could be seen as a high-risk negotiating strategy but seems to have significantly damaged trust to the point where the EU is threatening to seek legal assistance to uphold the treaty. Société Générale has raised the threat of no-deal to 80% probability and any deal that can be achieved of limited scope[i]. They estimate that this scenario will knock 3% off UK GDP in the medium term, which is the mid-point of the Bank of England’s own 2.5%-5.5% range to 2024, while only affecting the EU by 1%. Furthermore, Karen Ward of JPMAM believes a no-deal will see sterling weaken 10%. Therefore, the risk to sterling is once more to the downside in the short term which will probably once again prove positive for the large cap UK-based stocks with substantial overseas earnings.

Finally, we believe that a persistent inflation threat will need to see the strong recovery that we have witnessed so far in the developed world continue. However, this may be checked by a second wave of the virus and there remain concerns over the further levels of fiscal support that governments will be able to provide to fundamentally weak underlying economies. Regardless, the perception of an inflation threat can drive markets and a defensive position for investors could rely on the support gained from real assets such as commodities. Increased supply will possibly check the price of oil, but industrial commodities have seen higher prices over the last month. Few assets benefit from higher inflation but commodities usually do, offering protection as strengthening demand causes prices to rise. Furthermore, commodities tend to bear a negative correlation to stocks and bonds so are a useful addition to a multi-asset portfolio and may reduce overall portfolio volatility.  Gold also remains a useful diversifier for investors despite the rally year-to-date when real yields are so low and geo-political risks so high.

 

[i] UK Heading for No Deal – Brian Hilliard & Yvan Mamalet – 17/09/2020

 

 

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