Blog

By Andrew Butler-Cassar, Hottinger Private Office

So we have another three letter acronym to get used to, no not my initials but WFH, ‘working from home’. Some will wonder what all the fuss is about, as working remotely, as it is otherwise known, has been an everyday occurrence. In the blink of an eye, lockdowns ordered, we became work from homers, when once remote working was stigmatised in the office, with quips about ‘working from the sofa’ or “oh yes they are ’working from home’ today” with often exaggerated speech mark hand signals. Now I realise I need a new chair for my workspace and everyday feels like Tuesday. This article explores our new ‘acceptance’ but asks what are we actually willing to accept and will it last?

I don’t think there are many that would deny it was quite a novelty working remotely. No early morning alarm clock, no rush to the station for the commute to work and wow, the money we’ve saved from not buying the expensive coffee and a wildly over-priced sandwich from the local café at lunch. Clearly our savings, of course, have been someone else’s business crisis. The cost of the pandemic in both human terms and economic has been well documented, but I can’t help thinking that most of us have enjoyed the initial change of pace.

Without for a moment wishing to belittle the seriousness of this ongoing pandemic and how grateful we are to those on the frontline, being at home brought out many firsts for us all. Until the pandemic, I thought Zoom was Fat Larry’s greatest hit!  Virtual quizzes and curry nights, the ease with which family members or friends could be in contact with you perversely meant more contact, not less in a lockdown. In fact, I wonder if ten years ago, well maybe 5 years ago, we would have been able to adapt so easily to working from home? We have much to thank our technology for. Beyond the initial happiness connections brought via all manner of video conferencing apps, what has been the effect on a normal working day? Communication in our line of work is crucial, none more so than in times of increased volatility, and whilst some competitors used WFH as an excuse to be less communicative, we jumped at the opportunity to connect more frequently because our clients adopted the technology seamlessly. A recorded video call to discuss markets and/or review recent advice has now become an acceptable additional medium but we don’t believe it should substitute good old-fashioned face to face contact. Anecdotally, as an advisor our personal lives, or shared moments, are what strengthens a client/adviser relationship over many years. Thinking back to sharing the news of the birth of my first child with my long standing clients brings it all very much to life when that new born child you spoke of so fondly now walks into your conference call, sixteen years later asking, or should I say grunting, for money to go shopping! We both chuckled at what was clearly a moment they had endured themselves with their own children and I think it is these moments that strengthen the relationship beyond the quality of the advice given.

Although many businesses have coped well during the pandemic, there are some obvious exceptions. The leisure and tourism industry has been decimated, you can’t go on holiday via a conference call, you can’t go to the theatre, live gigs or nightclubs (thank you NT Live et al for the culture we are enjoying via YouTube but we all want our Arts back to normal as soon as possible).

However, most of us would also agree that working remotely has not meant less productivity in fact it has been quite the opposite. So, if this is the case why have we not adopted this sooner? Nicholas Bloom, a professor at Stanford University in California thinks the attitudes around working from home are finally changing[i]. In his experiment in 2013, Bloom worked with the Chinese travel company Ctrip, to study remote-work productivity. Somewhat to Bloom’s surprise, the company’s staff became notably more productive by working from home four days a week. 13% more productive. Now, six months into the global pandemic, an increasing number of companies are asking: should they work from home indefinitely? And if they do decide to make major organisational changes about remote work, could they see similar leaps in productivity?

Whilst businesses are assessing the rise or fall in productivity, are they in equal measure concerned about the effect a substantial change in working habits will have on the mental wellbeing of their staff? If working from home becomes the new normal you may never see your work colleagues again except for the virtuous circle of videoconference calls, and give it time, our faces will be replaced by Avatars. In my case the team will be delighted by that development, equally think of the money I could save on haircuts!

Whilst it is ok to look for the humour in what has been an unprecedented time (impossible to talk about the past five months without the phrase unprecedented time) at Hottinger we are taking this seriously. As with many firms, morning meetings to ensure we check in with each other to see how we are coping are important, but we are all eager to get back something we have lost, ‘office banter’. The importance of human interaction between colleagues is not to be dismissed lightly, some of our team, particularly those who are younger and living alone have been very honest about the need for an office environment. Serendipity is important: bumping into people, seeing people in the corridor. Quite a lot of the ways that we make decisions in organisations aren’t made in meetings they’re made in the corridors. Yes, the newly created “12-month Barbados Welcome Stamp,” to be free to work on the island looks very appealing, but at Hottinger we believe our type of business requires an office-based approach to working.  However, WFH is not only acceptable but encouraged when members of staff feel it will be more productive, all you need for this to work is trust, a characteristic we live by at Hottinger.

[i]Article – Remote Control BBC Website – https://www.bbc.com/worklife/article/20200710-the-remote-work-experiment-that-made-staff-more-productive

 

 

 

plan it

By Tim Sharp, Hottinger Investment Management

The continuing rally in risk assets continues to feel out of step with our view that growth and earnings have been fundamentally impaired by the pandemic lockdown. There have been a lot of theories for this phenomenon including lower summer trading volumes and an increase in retail day traders missing the opportunity to bet on sports. It is interesting that retail names such as Tesla and Amazon continue to lead US equity markets with Tesla becoming the world’s largest carmaker by market capitalization, overtaking Toyota despite only creating 500,00 cars a year! It is difficult to justify such lofty valuations even with the significant dispersion between winners and losers, or growth and value.

Absolute Strategy Research (ASR) points out the relative expensive state of US equities in general; US equities are on a 60% PE premium to the rest of the world and are trading on a price-to-book ratio that is also 2.3 times higher. Over the last week the Nasdaq 100 which is heavily laden with technology stocks has seen a significant outflow of funds which may indicate that short term investors are also considering the technology leaders to be looking expensive. Current data would indicate that the US is seeing a significant spike in new virus cases, particularly in the more populated states. Although fatality rates are not rising in step due to the younger demographic that is contracting the virus through poor social distancing, this will have an inevitable effect on economic activity just when the economy seemed to be recovering quickly.

ASR use Technology vs. Banking as the proxy for Growth and Value and it is not often that stock markets can undertake a prolonged rally without carrying the banking bedrock of the real economy with it. This is more noticeable in Europe where the banking sector is still the main conduit for corporate funding and the introduction of government support. The European economies seem to have opened more successfully than other developed economies, seeing consumer activity bounce back quickly and safely, suggesting that a more prolonged recovery may be possible in Europe at this time. We expect investment opportunities to present themselves in Europe and ASR argue that it is difficult to like European stock markets without supporting the banks. The set of fiscal policies including the latest EU Recovery Fund would have been unlikely pre-pandemic, but these developments will likely change the eurozone approach to stimulating demand and improve collective risk sharing between nations.

The Chinese economy has bounced back sharply with manufacturing and service sectors once more in expansion territory and the property market activity also strong. China has benefitted from the global demand for medical supplies and IT equipment but is likely to see economic activity sustained as the developed world begins to re-open. Over the last month Chinese stock markets have been strong emulating the optimism in the real economy, however, tensions with the US and UK remain leaving an underlying anxiety among investors.

The underperformance of the UK stock market due to the ongoing uncertainty of trade negotiations with Europe has been a theme this year but there is a fear in certain quarters of the Japanification of the UK economy. However, the convergence of nominal rates at the long end of the government yield curve under-estimates the ability of the UK economy to create inflation unlike Japan, so real rates are actually diverging approaching -3% in the UK. Furthermore, the UK is running a current account deficit of 3.3% of GDP, second only to Brazil, while Japan has a 3.6% surplus. This suggests that sterling, which has been held down by Brexit since 2016, is unlikely to strengthen in the near term when interest rates are anchored close to zero.

ASR research monitors growth in money supply as a signal of a potential rebound in economic growth and the surge in money supply over the last quarter has been held up by some as a sign that there will be a strong rebound in economic activity. However, this may also be the result of central bank accommodation of government fiscal policy and companies using credit lines to drawdown cash rather than proof of a strong recovery.

The rally in gold has not gone unnoticed with the price in US dollars now above $1800/oz approaching levels last seen in 2010 / 11. There is a possibility that this may provoke some profit-taking especially with discussions regarding future inflation back on the agenda but within a multi-asset portfolio precious metals still offer a hedge to equity volatility and any perceived weakening in the US dollar.

There is a possibility that the default rate is being underestimated by markets thanks to central bank intervention and that insolvency will become a problem during the second half of the year as that support falls away but lockdown scarring affects the return of economic activity. We remain cautious on low rated companies but believe there is value in the yield pick-up of medium duration, investment grade corporate bonds over government bonds.

 

plan it

By Tom Wickers, Hottinger Investment Management

The UK economy is open for business. Non-essential shops, restaurants and pubs have tentatively wiped down their counters and unlocked their doors as the British public reacquaints itself with liberties we all took for granted just six months ago. Last week, the UK officially started its travel corridors with over 70 countries and Oliver Dowden, the culture secretary, announced that leisure and entertainment will be making a comeback in the form of swimming pools, theatres, and music venues. Freedom tastes so sweet, or does it? The natural flipside of the coin which is plaguing the minds of analysts and households alike is the potential for a second wave of the virus. After coming so far, now would seem a fitting time to assess whether we have come far enough to recover from this pandemic.

Figure 1: Daily confirmed COVID-19 cases as of 13th July 2020. Source: ourworldindata.org[i].

So, can we avoid a second wave? The simple answer appears to be yes, as some Asian countries have managed to do so emphatically. However, there are a number of niggly caveats to this assertion that will likely mean some countries do have second waves. The ability to limit COVID-19 spread will be determined by the extent to which countries want to open their economies, the protocols in place and whether the public heeds safety advice. As such, it may be that some western countries have already opened up their economies too far without the proper advice in place. The United States is the elephant in the room, but UK government policy is another example. A requirement to wear protective masks when shopping has only just been announced by the UK government, yet for some time there has been evidence to suggest that it could be a crucial factor in determining whether economies experience a second wave[i]. COVID-19 could be airborne, according to studies, meaning that transmission can occur through breathing as well as the larger droplets from sneezing and coughing that are commonly associated with flu. The implication is that the virus transmission rate may not be controllable if indoor activities are permitted without suitable protection.

Additionally, super-spreader events have led to many of the outbreaks we have seen in eastern and western economies alike and have been estimated by some to cause up to 80% of secondary transmissions[iii]. A super-spreader choir practice held near Seattle in March was studied and it was found that 53% of the room became infected within 2.5 hours[iv]. Identification and prevention of these events will be crucial in limiting the number of outbreaks, meaning some aspects of life will not return to normal in most economies until a vaccine is found.

It is no secret that some countries have contained the virus more successfully than others. According to one of the most prominent Chinese COVID-19 scientific advisors, Zhang Wenhong, the outbreak “has already ended” for China[v]. A crucial explanatory factor for the disparity in the effectiveness of lockdowns is unsurprisingly held in the efficiency of the track and trace system run in that country. More specifically, test frequency has been found to be substantially more important than test sensitivity in tracking the virus and counteracting outbreaks[vi]. While there can be false negatives and positives from poor sensitivity, what matters most is being able to detect proportional increases in infection rates sooner rather than later. Any government that does not have an efficient or decisive system will struggle to contain waves and outbreaks, which helps explain why China and Germany were so adept in containing the virus.

One key debate that keeps circulating regarding the virus is whether opening up economies is worth the risk of further outbreaks and a second wave. Some countries, such as Iran, have already announced they will not be able to shut down again. From a medical standpoint, the death rate from the virus would be weighed against the number of deaths caused by poverty or neglect. The number of deaths caused by lockdowns is likely to be the subject of many future studies. However, only the death rate attributed to the virus can currently be fully examined and estimated. At the start of the global crisis in March, the COVID-19 death rate estimates ranged from 0.1%, comparable to that of flu, to 2%. Scientific studies have since narrowed that uncertainty somewhat to a range of figures between 0.5 – 1.0%[vii]. The current discrepancies are partially due to uncertainty over true infection rates, stemming from two large information barriers that we are all aware of; that most governments cannot conduct as many tests as required to fully track the virus and that the virus figures have become political, with some countries not publishing representative figures. Irrespective, the fear of overloading hospitals has lessened, and many healthcare systems are confident that they have capacity for a second wave[viii]. Furthermore, drugs such as Remdesivir will aid in reducing the death toll. A second wave of COVID-19 will, however, exact a sickening toll on populations if the virus is allowed to spread unchecked. As an illustration, Imperial College London have estimated that the lockdown in Europe saved around 3.1 million lives[ix].

To determine whether an open economy is worth the risk from an economic perspective, we can evaluate whether it has been worthwhile for those countries that retained more permissive restrictions in the first wave of global infections.

Figure 2: The relationship between changes in a country’s number of new cases per month and the changes in a country’s PMI figures for that month. The relationship is assessed for countries with a low stringency index compared to the proportion of their tests that are positive[x]. A line of best fit is shown for both scatter graphs[xi]. The number of cases is on a logarithmic scale to account for the exponential nature of a virus spread.

Figure 2 assesses the economic performance of countries that have been the most lenient with virus-related restrictions considering their respective infection rates[xii]. Most of the countries are those you would expect from recent headlines, including Sweden, Brazil and the United States. The figure illustrates a strong negative relationship between COVID-19 figures and economic figures, particularly in services, which suggests that not locking down does not save an economy. The public has tended to take matters into its own hands by reducing its activity and exposure without the need for enforcement, as exemplified by the response in Sweden[xiii]. Sweden’s economy slowed just as much as its European counterparts that went into lockdown and yet its neighbouring countries have made much more progress in reducing infection rates. Hence, unless there is a change in behaviour towards increasing virus levels, a surge in virus levels should almost be avoided at all costs – especially for developed economies that are highly concentrated in the services sector.

While countries are enjoying their new liberties, they should err on the side of caution at all times. Rapid tracking, tracing, and countering has proved very effective, but many countries are yet to be able to instigate such a diligent system and much uncertainty remains in best-practice to safeguard against the virus. However, it will be difficult to justify risks taken if they lead to a second wave of infections, which would cause severe damage, when a second wave does not appear to be an inevitability.

[i] https://ourworldindata.org/covid-cases

[ii] https://www.nature.com/articles/d41586-020-02058-1

[iii] https://wellcomeopenresearch.org/articles/5-67

[iv] https://www.cdc.gov/mmwr/volumes/69/wr/mm6919e6.htm

[v] https://www.globaltimes.cn/content/1194123.shtml

[vi] https://www.medrxiv.org/content/10.1101/2020.06.22.20136309v2

[vii] https://www.nature.com/articles/d41586-020-01738-2

[viii] https://www.theguardian.com/world/2020/jun/22/why-doctors-say-uk-better-prepared-for-second-wave-coronavirus

[ix] https://www.bbc.co.uk/news/health-52968523

[x] https://ourworldindata.org/coronavirus/country/united-states?country=~USA

Conducted on a subset of countries where the ratio is low for Stringency index (the maximum employed this year) versus total cases (logarithmic)/no. of tests. This effectively determines countries that have not employed strict measures in line with the danger to their citizens compared to the rest of the world. The model is simple so subject to flaws but as an approximation has been deemed appropriate.

[xi] The manufacturing line of best fit ignores two outliers, the services line of best fit ignores on outlier.

[xii] The countries that exhibit this characteristic and also have PMI figures are Sweden, Brazil, Mexico, Qatar, Nigeria, Indonesia, Colombia, South Africa and the United States. Only Sweden, Brazil, Nigeria and the United States have Services PMI numbers.

[xiii] https://www.marketwatch.com/story/sweden-didnt-impose-a-lockdown-its-economy-is-just-as-bad-as-its-neighbors-who-did-2020-06-25

 

By Laura Catterson, Hottinger Investment Management

The US dollar dominates global trade. It accounts for over 60% of the world’s currency reserves and in 2019, was involved in 88% of all transactions.[i] The Euro follows at over 20% and 32% respectively.[ii] This gives the US extraordinary power over anyone who imports or exports anything, anywhere. Commodities such as oil, gold & coffee are all priced in dollars regardless of where they come from. This clout has long frustrated America’s rivals – the centrality of the US dollar in the global payments system cements the potency of US trade sanctions and thus America’s dominance. Even amid the chaos of the coronavirus outbreak and collapsing global financial markets in late March, international investors sought refuge in the dollar. As it stands, any alternative has to overcome too many hurdles to make a viable play for the greenback’s current reign, and thus, the real test for the dollar’s endurance rests on Washington’s ability to weather potential storms and produce economic policies that enable the country, over time, to manage its national debt and curb its structural fiscal deficit.[iii]

The dollar came to dominate trade after World War II. Whilst countries were trying to rebuild, the US economy was strong resulting in a stable and plentiful dollar. In 1944 a conference of 44 nations decided to peg their currencies to the US dollar while the dollar itself was pegged to gold. As global trade grew so did the use of the dollar to conduct the world’s business. Even after the US abandoned the gold standard in 1971, the dollar remained the world’s currency of choice due to its liquidity and the efficiency of the US banking system.

Sceptics of the dollars continued stature point to the “rise of the rest”. The European Union has continued to further promote the Euro in international transactions and, although hit hard by the current crisis, it has grown its reserve currency status over the past 21 years sitting second only to the dollar. One factor that could further its advance is the European Commission’s plan to fortify its recovery budget for COVID-19 bailouts by issuing debt that will be repaid in EU-wide taxes. Some argue this could become the basis of a true fiscal union prompting more people to hold Euros.[iv] However, this proposal has been met with fierce resistance from some EU capitals, highly suspicious of granting Brussels with fresh resources. The euro-zone crisis has also cast significant doubt on the currency’s long-term dominance with the Italian budget deficit near 10% of GDP[v], France; 11.4%[vi] and Germany; 7.25%.[vii]

Former United States treasury secretary, Henry Paulson, argues that the Chinese renminbi (RMB) has the greatest potential to assume a role rivalling that of the dollar [iv] China’s size, prospects for future growth, integration into the global economy and accelerated efforts to internationalize the RMB all favor an expanded role for the Chinese currency. Yet, by themselves, these conditions are insufficient. Beijing has major hurdles to overcome before the RMB can emerge as a global currency let alone dethrone the dollar. China needs to make more progress in moving to a market-driven economy, improve corporate governance, and develop efficient, well-regulated financial markets that earn the respect of international investors. However, they show no inclination to abandon capital controls and make the Yuan fully convertible which only further delays the RMB’s potential advance.

When it comes to the primacy of the dollar, the main risk stems from Washington itself. The dollar’s status reflects the soundness of the American political and economic system. To safeguard the dollar’s position, the US economy must remain a model of success. That, in turn, requires a political system capable of implementing policies that will allow more Americans to flourish and achieve economic prosperity. It also requires a political system capable of maintaining the country’s fiscal health. No country has remained on top without long term fiscal prudence thus it is vital the US responds positively to today’s economic challenges.  US foreign policy is also of huge significance in maintaining the dollar’s edge. Policy choices abroad affect US credibility and, to a large extent, determine its ability to shape global outcomes. Washington must therefore be mindful that unilateral sanctions – made possible by the primacy of the dollar – are not free of cost. Weaponizing the dollar in this way can energize allies and foes to develop reserve currencies. Fortunately for the US, Iran, Russia and Venezuela have attempted to work around the dollar’s key role but with limited success.[viii] Major economies appear unwilling and unable to join forces in an attempt to dominate the dollar however, the US should not be complacent.

Above all, the United States must preserve the conditions that created the dollar’s supremacy in the first place. A thriving economy rooted in sound macroeconomic and fiscal policies; a transparent, open political system; and economic, political, and security leadership abroad. In short, sustaining the dollar’s status will depend almost entirely on the United States’ ability to adapt its post-COVID-19 economy so that it remains a model of success. Taking initiative to adjust and update global rules and norms that govern trade, investment, and competition in technology will also be key. With success in these areas, the dollar’s reign will remain unchallenged.

[i] https://data.imf.org/regular.aspx?key=41175

[ii] https://www.tradersmagazine.com/am/88-of-all-2019-forex-transactions-are-in-us-dollars/

[iii] https://www.foreignaffairs.com/articles/2020-05-19/future-dollar

Figure 1: https://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4

[iv] https://www.ft.com/content/68e5f028-a1a1-11ea-94c2-0526869b56b0

[v] https://www.reuters.com/article/us-health-coronavirus-italy-budget-exclu/exclusive-italy-sees-2020-budget-deficit-near-10-of-gdp-source-idUSKBN21Y2U9

[vi] https://www.reuters.com/article/health-coronavirus-france-deficit/french-budget-deficit-seen-at-114-in-2020-minister-says-idUSFWN2DG0W8

[vii] https://uk.reuters.com/article/us-health-coronavirus-germany-budget/germanys-debt-plans-create-budget-deficit-of-7-25-this-year-sources-idUKKBN23M14E

[viii] https://www.brookings.edu/wp-content/uploads/2019/09/DollarInGlobalFinance.final_.9.20.pdf

By Kevin Miskin, Hottinger Investment Management

The rally in global stock markets showed no sign of abating in the early part of June as countries started to emerge from lockdown, further stimulus packages were announced and the economic data supported the view that there would be a ‘V-shaped’ recovery from the pandemic.

In Europe, Angela Merkel’s coalition negotiated a larger-than-expected €130 billion stimulus package that will provide an immediate boost to the economy through a relaxation of value-added-tax while France introduced a broader €45 billion stimulus plan [i]. Meanwhile, the European Central Bank (ECB) dispelled any doubts over whether it would act as lender of last resort by announcing an expansion of its bond-buying programme by a further €600bn [ii]. This latest action has taken the combined balance sheets of the eurozone, US, Japan, UK and China to more than $23 trillion from just $5 trillion in 2007, according to Haver Analytics.

The economic data from early June was similarly supportive. US and Chinese Purchasing Managers Indices, which measure the prevailing direction of economic trends, continued to improve, while Chinese new orders increased at the fastest pace in a decade. Yet, the data that caught investors most by surprise, and caused the US President to declare the recovery a “rocket ship”, were the US jobs numbers. The report showed 2.5 million jobs had been created in May with the unemployment rate having fallen to 13.3%, versus an expected rise to 20%[iii].

The market reaction to this bout of upbeat news was emphatic; the S&P500 index completed its best 50-day run in history (according to Barclays) having risen by more than 40% since the March lows. Meanwhile, longer-dated US Treasuries sold off; the yield on the US 10-year rose to 0.90%, its high level since mid-March, while the gap between the 5 and 30 year part of the yield curve widened to its steepest in almost three years.

Yet, the surprisingly good US unemployment report marked a peak for both US and global equities, not least because a closer inspection of the US jobs numbers revealed the rebound in hiring had been flattered by the structure of the US federal aid programme while permanent lay-offs rose by nearly 300,000 [iii].

At about the same time, the World Bank and US Federal Reserve (Fed) provided a more sobering view of matters which brought President Trump’s “rocket ship” recovery and risk assets back towards earth. The former said the global economy would contract by 5.2% this year, marking the fourth-deepest recession since 1900. Developed countries economies were predicted to contract by 7% on average, with emerging nations’ set to fall for the first time in at least six decades [iv]. Meanwhile, the Fed estimated that by 2022, the US would still have an unemployment rate of 5.5%, far higher than the pre-Covid level, with core inflation still below its 2% target level.

It also held interest rates at 0-0.25% by unanimous vote and pledged to continue buying Treasuries and mortgage-backed bonds at least at the current rate. Fed chair Jay Powell added “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates”.  However, the US central bank did admit to considering “yield curve control” a more arcane approach dating back to the 1930s involving targeting interest rates along the yield curve.

The timing of the Fed’s downbeat economic outlook was unfortunate as it coincided with fresh concerns that a new wave of Covid infections was emerging in parts of the US, China and Europe, thereby amplifying the fall in risk assets.

For its part, the Bank of England maintained the Base Rate at 0.1% and announced that it would inject an additional £100 billion into the UK economy but at a reduced pace [v]. Governor Andrew Bailey explained the UK and global economies were healthier than the bank had expected, hence the reduction in pace, but the Bank felt more quantitative easing was necessary because the medium-term outlook was more troubling, especially for the labour market. Pantheon Economics echoed Andrew Bailey’s caution and warned that whilst the headline unemployment rate remained steady in April, the slump in vacancies pointed to a second wave of redundancies in the autumn as the furlough scheme comes to an end.

Four years on from the Brexit vote and there appeared to be encouraging signs that both sides were working towards a potential compromise.  However, June ended with continued disputes over state aid rules and Michel Barnier rejecting the UK’s latest proposal regarding how financial firms conduct business after Brexit. The end of June also marked the deadline by which the UK could have requested an extension to the transition period with the EU.

In terms of markets, the near-term concerns over a second wave of the virus combined with dour medium-term outlooks from central bankers did not prevent equites from building on their recent gains, albeit at a slower pace. The MSCI World Equity Index posted a gain of 2.5%, led by the Hong Kong and Chinese markets which rebounded strongly from the politically induced sell-off at the end of May. Elsewhere, the FTSE All-Share index gained 1.4% while European stocks comfortably outperformed their US peers (+6.0% versus +1.8%, respectively). US equities have outperformed strongly during the past ten years but a number of factors are starting to favour European markets, partly as a result of Covid. The European response to the crisis has been more decisive and could enable the region to open its economies more quickly than the US. The Covid recession could also be the catalyst for a recovery fund that could provide greater fiscal flexibility than before. Meanwhile, the US is experiencing a rise in new infections with some states including California having to retrench rather than re-open their economies. US valuations are also expensive, trading at a 45-year relative high premium of 1.6 times to global markets [vi].

US, UK and German government bond yields continued to trade within their three-months ranges, peaking early in June before retracing towards their lows, to the end of the month broadly unchanged and thereby maintaining their hedging qualities versus equities.

In commodity markets, gold appreciated by a further 2.9% to take its gain for this year to 17.4%.

Corporate bond purchases by the Fed and ECB directly injected liquidity into higher rated companies but also supported the high yield sector as investors searched further down the ratings curve for yield. Ultimately though, we remain cautious on low rated companies (single-B rated and below), despite signs that the default cycle might be more subdued than initially feared. During the month, we added to global corporate bonds through a fund which invests in medium duration investment grade names, thereby a picking-up yield over government bonds for limited risk.

 

[i] Bloomberg – Merkel Seals Stimulus to Lift Battered Economy; June 3, 2020

[ii] FT.com – Eurozone bond prices jump after ECB move; June 4, 2020

[iii] The Economist – American unemployment falls, but normality is still far away; June 5, 2020

[iv] The Economist – Business this week; June 11, 2020

[v] FT.com – Bank of England boosts bond-buying by £100bn but slows the pace; June 18, 2020

[vi] Absolute Strategy Research – Weekly Wrap; June 12, 2020

 

 

By Tom Wickers, Hottinger Investment Management

Hedge fund managers have featured heavily in financial news in recent weeks, highlighting their short positions and foretelling another stock market slump[i]. Valuations continue to look stretched to a significant number of analysts across the investment sector, but when stimulus is implemented on this scale, stock markets become flush with cash and economic recoveries become even harder to predict. Hedge funds, which are considered to consist of some of the sharpest minds in finance, find themselves placed at the extreme end of market pessimism, which bodes the question, should other investors be taking heed?

Hedge funds were created as early as 1949 but made their names in the dot-com bubble at the turn of the millennium. The industry led the market in driving prices in technology stocks but timed its exit well as the market peaked[ii]. The result was that the HFRX Global Hedge Fund Index made annual returns of 16.1% between 1998-2003 in stark contrast to the S&P 500 returns of 4.5%[iii]. Financial rock stars were born such as Neil Woodford and Steve Cohen and since then, bright talent and investors’ cash have been attracted to the industry like bees to honey. In 2003, there were 3,000 hedge funds managing $500B of asset. At the end of last year, despite years of poor performance, there were 11,000 hedge funds managing $3.5T[iv].

It is no secret; the hedge fund sector is not currently held in such high esteem. Investment managers, that are able to short securities and otherwise create unconventional investment strategies using derivatives, used to be the pride of Wall Street. Not only did hedge funds make exceptional returns through arbitrage strategies but their reading of the market was also thought to be second to none.

However, after an extended period of dismal returns, asset managers are beginning to think twice about their allocation to alternative strategies. Figure 1 shows the returns of the Hedge Fund industry since the S&P 500 and the HFRX index recovered from the 2008 Global Financial Crisis (GFC). Over this time, the hedge fund industry has returned an average of just 0.57% per year and the Sharpe ratios do not look much prettier. There are some winners among hedge funds, the Renaissance’s Medallion fund being a reputed one, however they are few and far between.

The pressure has mounted on hedge fund managers’ returns as arbitrage opportunities have become relatively scarce while fees have remained steep. The standard hedge fund fee of two and twenty, when added to muted gross returns, makes investor frustration with net returns even more understandable. In some ways the industry has fallen victim to its own success; as the number of hedge funds has risen dramatically and competition has increased, making opportunities hard to come by. Furthermore, returns from arbitrage strategies aimed at exploiting differences in global economic policies are being hampered by historically low interest rates experienced globally since the 2008 Financial Crisis.

Fund performance is not the only selling point for hedge funds as many investors have also traditionally invested to gain access to the sector’s ‘best ideas’. Idea conferences are held where hedge fund managers disseminate their favourite stock picks to eager ears. However, Epsilon Asset Management has recently analysed the historic returns of these stock picks and found that the ‘best ideas’ performed no better than hedge funds’ regular ideas[v]. The result is that the image of pristine predictive power that these fund managers used to embody has been tainted; investors have begun to lose faith in hedge funds and over recent years the industry has been experiencing net outflows[vi].

The hedge fund industry’s recent performance and predictions during the longest recorded equity bull market have not been noteworthy, yet some might argue that predicting recessions and downturns are a different kettle of fish. Good market timing is a skill that every investor wishes they had but few seem to exhibit. Hedge funds do appear to perform better than their peers in this regard. A study in 2017 found evidence that hedge funds that are more active in positioning around economic cycles outperform their less active counterparts[vii]. However, the study also found that the active funds were hit hardest during the 2008 Financial Crisis, which questions the industry’s more recent positioning in severe recessions[viii].

Predicting market movements is extremely difficult at the best of times. When the world is dealing with an unprecedented pandemic shock, the job becomes even harder as hugely influential factors such as new virus cases and the potential for further stimulus shift daily. The hedge fund industry has demonstrated some market timing ability and navigated the dot-com bubble expertly, but has also lacked market-beating predictions in recent times and failed to position well for the GFC. Short positions in the hedge fund industry probably shouldn’t be seen as a red flag any more than warnings from investment managers in other sectors. It is clear that the average investor is of similar mind as demonstrated by the market’s continued upward trend in the face of hedge fund warnings. It may be that a second market dip does occur, and we continue to be positioned defensively out of concern for this possibility, but our main causes for concern will continue to come from economic figures and statistics rather than the positioning of others in this crisis.

[i] https://www.ft.com/content/0ddb5f58-7989-4ec1-b531-bd76e0a8822a

https://www.ft.com/content/e1e1c3ef-1849-46bc-a472-2af8c0aabe5b

https://www.ft.com/content/9cc21492-099a-4639-8d7c-c5a9b3f465ce

[ii] M. Brunnermeier et al., ‘Arbitrage at its Limits: Hedge Funds and the Technology Bubble’, May 2002 http://www.econ.yale.edu/~shiller/behfin/2002-04-11/brunnermeier-nagel.pdf

[iii] https://blogs.cfainstitute.org/investor/2017/03/06/the-golden-age-of-hedge-funds/

[iv] https://www.bloomberg.com/opinion/articles/2019-11-25/the-hedge-fund-war-for-talent

[v] Epsilon Asset Management, ‘Hedge Fund Alpha and their Best Ideas’, April 2020 https://www.epsilonmgmt.com/research/hedge-fund-best-ideas

[vi] https://www.evestment.com/news/covid-19-crisis-shifts-hedge-fund-flows-negative-in-march/

[vii] M. Brandt et al., ‘Can Hedge Funds Time the Market?’, June 2017 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2988484

[viii] https://www.institutionalinvestor.com/article/b1505qrv393rd2/even-the-most-skilled-hedge-funds-are-bad-at-predicting-crises

By Tim Sharp, Hottinger Investment Management

US Federal Reserve President Powell used the post June Federal Open Market Committee meeting press conference to inject an element of reality into the recent equity rally that has seen the NASDAQ top 10,000 and the S&P500 go positive fleetingly for the year. The sobering reality that the Fed will not even be thinking about thinking about raising rates until 2022 and leaving its level of bond buying unchanged, made equity investors finally sit up and take notice. Equity market volatility could be compared to a pendulum that probably overcompensated to the downside to March 23 and has overreacted to the upside with one of the longest and sharpest bear market rallies pushing areas of the market to very stretched valuations. Thursday’s pullback is the beginning of share prices trying to find the right valuation levels based on what we know now. Following the technical bounce Absolute Strategy Research expects a demand shock lasting a couple of quarters and a longer-term supply shock as delicate supply chains are impacted by the pandemic, both pointing to ongoing credit and equity market stress[i].

Over the last 4 weeks the financial markets and real economies have been focused on the gradual reopening of countries following the lockdown periods. A couple of hot spots in South Korea were quickly tracked; New Zealand declared themselves Covid-free and European countries have so far kept their infection rates down. The clear winners have been countries with mass testing capabilities and efficient track and trace technology, such as, Germany and Scandinavia ex Sweden. Unfortunately for the US and the UK neither system has been up to scratch and so far 18 US states including California and Texas have seen a spike in Covid-19 cases  and the North West of England has seen its R-rate rise slightly above 1 leaving schools in the area unable to partially open once more.

The rotation from lockdown winners into traditional cyclicals that has taken place over the last fortnight will probably be reversed with the threat of a second wave of the virus, however, as Treasury Secretary Stephen Mnuchin told CNBC on Thursday, June 11, shutting down the economy for a second time is not a viable option. It is our opinion that the financial cost of continued lockdown has been calculated to far outweigh the threat to human life leaving many countries who were hoping to eradicate the virus before the summer tourist season started with little option but to leave the population to make its own decisions regarding participation or risk devastating a major part of their economies.

We suspect investors will focus on the countries that come out of lock down the healthiest and currently that would point to the eurozone, meaning that the lead taken by US equity markets up to this point may well be rivalled by European stock markets. There is no doubt that there are trends within cloud technologies that will be very disruptive and enduring, but opportunities within Europe may show themselves as the global economy continues to reopen despite the consequences. Furthermore, the proposal for a EUR500bn stimulus fund financed by jointly issued government debt is a significant moment for Germany with its resistance to debt mutualisation, and a major fillip for ECB flexibility in the sharing of funding risk, although it is yet to receive full support.

The second observation is that the monetary and fiscal stimulus including the Fed’s reiteration that it will continue to buy bonds, government and corporate, has underpinned the default rates within global credit. High yield has less direct support and has seen most ratings downgrades. The support has restored confidence in corporate credit and with government bond yields so low it allows investors to focus on pure credit spreads particularly investment grade. However, the natural negative correlation between long-dated government bonds and equities can still provide a hedge in multi-asset portfolios. Investors may need to be more flexible in their investments to allow for swift adjustments in duration depending on the climate within equity markets. For example, the pullback in the S&P500 over the past week has been largely offset by the over 15-year US Treasury total return index. Traditional buying of government bonds for yield is no longer effective while interest rates are so low, but in a multi-asset portfolio, they provide capital preservation and a meaningful hedge to equity risk.

Gold has been the best performing asset class this year supported by a flight to quality, falling interest rates and probably most significantly a weakening dollar. The path of the dollar will be crucial to the recovery of the global economy, however, the continued problems in emerging markets will favour dollar strength whereas its relative performance against reopening developed economies may favour the euro and the yen; sterling remains a victim of no-deal uncertainty.

In conclusion, it is unlikely, in our opinion, that the global economy will normalise until a vaccine is found and it is worth remembering that the number of Covid-19 cases globally is still rising with devastating consequences for the populations of the developing world with under-funded and under-prepared health services. The full extent of the effect on the growth potential of the emerging world is yet unknown but it is interesting that countries have become non-collaborative and isolationist during this pandemic unlike the Global Financial Crisis when the power of collective action was very evident.

 

[i] Absolute Strategy Research – Investment Committee Briefing for June 2020; June 5, 2020

By Tim Sharp, Hottinger Investment Management

The economy has been put into a self-induced coma to halt the spread of Covid-19 and the resulting economic downturn has been significant, requiring major support from the Bank of England and the Treasury. With the turning of June comes the first tentative steps out of lockdown on the road back to normality. A V-shaped recovery is the perfect result where the economy bounces back quickly with the R-rate remaining steadfastly below 1. We have discussed the alternatives to this optimistic scenario in previous articles while the World Bank warns that we may be heading for a global recession[1].  The quickest way to reduce the economic consequences of the pandemic is to re-open as quickly as possible and countries are increasingly shaking off the restrictions imposed during lockdown. The downside to this scenario is of course a second wave of infection which once more threatens the tender shoots of recovery.

Last week saw Michel Barnier and David Frost reopen negotiations regarding the future trade relationship between the UK and the EU with the rather inevitable result that both sides remain entrenched in their opposing positions. The week before, Mr Barnier wrote to UK party leaders to advise that the EU is open to extending the transition period by up to two years to allow time for a trade deal to be concluded. EU Commission President Ursula von der Leyen has called for a six month delay and business leaders in Northern Ireland have said that companies do not have the financial capacity to deal with new post-Brexit arrangements following coronavirus, also demanding a six month delay[2]. However, Boris Johnson and David Frost remain adamant that a trade deal must be signed by December 31, 2020. Following the stalled talks this week the next meeting will be between Mr Johnson and Ms von der Leyen, likely to take place in conjunction with the next EU virtual summit around June 19.  It is worth remembering that the last time that the UK can legally agree to extend the timetable is the end of June, therefore, the mid-June meeting takes on new significance. The rotating presidency of the EU commission moves to Germany in July and Angela Merkel promises an intense negotiating agenda with a view to ratifying an agreement at the October summit.

Right now, with the talks currently in deadlock, Britain and the EU are once again confronted by the prospect of a no-deal at a time when both economies have been ravaged by Covid-19 and the shape of any recovery is still in the early stages of formation. Julian Jessop, fellow at the Institute of Economic Affairs writes in the Financial Times that the risks to the economy from no-deal are likely to have less of an impact than Covid-19. British government analysis in 2018 expected a no-deal Brexit to lower UK economic output by at worst 8% over a 15-year period. The Office of Budget Responsibility forecasts that Covid-19 will reduce UK GDP by 13.8% this year[3]. The theory goes, therefore, that the current crisis will ease some of the side effects of dealing with a no-deal exit, taking pressure off major ports and making the case for greater re-shoring of business. The flip side of this argument is why add further pain to the already significant economic problem created by the pandemic lock down. The UK is struggling with one of the highest fatality rates per capita in the world after delaying lockdown making reopening fraught with anxiety.

Even though the pandemic fallout will disguise the impact of no deal, it will not eliminate it, with the inevitable result of slowing the economic recovery from the pandemic recession. Many companies have had to increase debt levels to ensure survival and would find it difficult to adjust to no deal with a less flexible balance sheet. CBI chief, Carolyn Fairbairn, says that companies have “almost zero” resilience and ability to cope with a chaotic changeover and BOE Governor Andrew Bailey has contacted banks to ensure that they are properly prepared3.

Throughout May and again this week the pound vs. the Euro, the main market where Brexit disappointments are historically reflected, has weakened and once more resides at the 1.12 mark as financial markets reconsider the possibilities of a no deal exit. In fact, the pound is still to recover from the 20% dip it experienced following the 2016 referendum result. The FTSE 250 mid cap index, where more domestically focused companies reside, continues its mild underperformance of core Europe, -15.9% year-to-date compared to -13.5% for the French CAC 40 and -3.8% for the German Dax at the time of writing. However, this may be reflective of the success of each country in managing the pandemic rather than the UK-EU trade prospects. Regardless, some analysts are expecting further strain on the equities of UK focused companies over the coming months. Many of the arguments regarding the effects of a no-deal remain unchanged despite Covid-19 and, with the economy already suffering, this could be viewed as a good time to bury bad news.

[1] https://uk.reuters.com/article/us-health-coronavirus-worldbank/world-bank-sees-major-global-recession-due-to-pandemic-idUKKBN21L3EN

[2] https://www.ft.com/content/aedc4a01-75f3-4905-b9cb-abea7e06cc1c

[3] https://www.ft.com/content/4440f83d-7e8a-4510-b8b7-3fb9146da51a

By Kevin Miskin, Hottinger Investment Management

The UK experienced is sunniest spring since records began in 1929, according to the Met Office. Investors certainly saw few dark clouds in May as optimism spread over the nascent opening of economies and the potential for fiscal unity in Europe. But are there dark clouds of rising Sino-US tensions, negative interest rates, opaque company earnings guidance and a potential second wave of coronavirus looming on the horizon?

With China back at work for two months, much of Europe for two weeks and restrictions being eased in the US and UK, there have been almost no reports of a second wave of Covid. One exception could be South Korea where a spike in infections resulted in Seoul re-implementing lockdown measures at the end of the month. At the time of writing, markets have not reacted to this recent setback, but we watch with interest.

The economic backdrop remained mixed. Gross Domestic Product reports for Q1 painted a picture of the major economies heading towards recession; the US contract by 5%, the UK by 2% and China by 6.8%. The virus continued to take its toll on labour markets; 40 million American have filed for unemployment since the pandemic broke and the jobless count in the UK rose above 2 million for the first time in 1996. The unemployment figure would have been far worse in the UK without the furlough scheme which has helped protect over 8 million jobs but comes to an end in October.

Yet, there were signs of recovery. The Purchasing Managers Indices, which measure the prevailing direction of economic trends, started to recover globally in May, albeit from multi-year lows. Further, according to Neuberger Berman, on the ground credit card spending has picked up, as have contacts with estate agents, while some airlines have seen new bookings outnumber cancellations[i].

In terms of policy, central banks and governments continued to demonstrate that they have further firepower to deploy. In what could prove to be a milestone for the EU, the French and German governments proposed creating a €500bn recovery fund that would make fiscal transfers to the hardest-hit European countries without adding to their debt burden. For its part, the European Central Bank indicated that it stands ready to expand its €750bn pandemic stimulus programme of bond purchases should the need arise.

In the US and UK there was much talk about joining Europe in the introduction of negative interest rates. Central bankers, for the most part, have voiced their skepticism but the extent to which they have ruled them out has varied.  Bank of England governor Andrew Bailey said he was not contemplating negative rates in mid-May, only to say he was not excluding the idea a week later. His change of heart happened to coincide with a 3-year Gilt being issued with an average yield below zero for the first time. Meanwhile, the Fed has remained resolute that it does not intend to take rates below zero, despite repeated protestations from President Trump.

TwentyFour Asset Management noted that the minutes from the latest Fed meeting stated that it was prepared to use its balance sheet to keep “Treasury yields at short-to medium-term maturities capped at specified levels for a period of time”[ii]. Therefore, they believe, the US yield curve should remain relatively well anchored at around current levels until a recovery takes hold. Further, the Fed would like to keep a heathy level of steepness in the yield curve to assist the bank’s level of profitability while not allowing longer-dated yields rise too far to protect consumer mortgage rates. In such a scenario where duration risk is limited, medium dated high-quality corporate bonds should offer better value than shorter-dated high yield bonds where default risk remains uncertain.

In the equity market, US banks rallied strongly during the second half of May as investors clearly backed the prospect of a positive yield curve over negative rates. Other value sectors including industrials and materials also started to outperform towards the end of the month as investors bought into the prospect of an economic recovery. The broadening of the rally helped drive the S&P500 through the 3,000 level for the first time since early March. Elsewhere, European markets started to pick-up, buoyed by their bias towards economically sensitive sectors, the prospect of fiscal unity and government intervention; France will provide its car manufacturers with about €8bn of assistance and Germany will bail out Lufthansa to the tune of €9bn in exchange for a 20% stake in the company.

For the month as a whole, the technology and consumer discretionary sectors remained dominant, outpacing the banks and industrial stocks. The Oil & Gas sector remained under pressure despite a sharp recovery in the oil price.

By geography, Japan was the stand-out performer with the Topix index gaining 7%, followed by the US and Europe (+4%) and the UK (+3%). In contrast to western markets, stocks in Hong Kong and China ended the month at a loss. Beijing’s decision to pass a law curbing freedom in Hong Kong drew the ire of the US in particular. The Trump administration said that it no longer considers Hong Kong politically autonomous from China, a move that may jeopardize the city’s special trading status with America.

It is fair to say that there was encouraging news during May and we appear to have cleared the first hurdle of coming to terms with Covid-19 in China, Europe and the U.S.  Yet, risks remain. During the past month, UK chancellor Rishi Sunak warned the UK faces a “severe recession, the likes of which we have not seen”[iii], and US Federal Reserve chair Jay Powell told CBS news that US unemployment could rise as high as 20-25% over the next two months and a full recovery may take until the end of next year. Meanwhile in Europe, whilst the Franco-German fiscal plan marks a positive step forward, it has yet to be agreed by the so-called Frugal Four of Austria, Denmark, the Netherlands and Sweden. At least Britain is now a former member and not able to block it!

At a company level, 45% of S&P500 companies either revised or suspended guidance during the Q1 earnings season and analysts expect profits to fall by 20% this year, according to The Economist[iv]. ASR believe that corporate earnings will take longer to recover than markets expect having seen earnings take two years to recover after the global financial crisis in 2008 and, therefore, 2021 earnings estimates remain unrealistic[v]. Yet, global equities have rallied by more than 25% from their March lows and are just 8% from an all-time high.

In terms of asset allocation, we continue to believe we are seeing a strong bear market rally with insufficient fundamental information to establish a growth or earnings trajectory. Therefore, we remained defensively position during May, mindful of a second equity drawdown. We are, however, considering increasing our exposure to investment grade corporate bonds with medium duration as they offer a pick-up in yield and the opportunity for capital appreciation combined with relatively low risk.

 

[i] Neuberger Berman – Not Out of the Wood; May 24, 2020

[ii] TwentyFour Asset Management – Yield Curve Boosts Case for Longer Dated Credit; May 21, 2020

[iii] Bloomberg – Sunak Sees U.K. Recession on Scale ‘We Have Not Seen’; May 19, 2020

[iv] The Economist – An earnings season to forget; May 14, 2020

[v] ASR’s Ian Hartnett, CNBC’s Squawk Box Europe; May 14, 2020

 

 

 

By Tom Wickers, Hottinger Investment Management

In the wake of the Covid-19 crisis, very few companies have flourished. Those that had infrastructures tailored towards the lifestyles of homebound consumers, such as Amazon and Netflix, have been the main success stories. As such, Big Tech led the charge in the US April stock market rally, leaving the NASDAQ in the green for 2020[i] at the time of writing. The other main sector that has had a strong influence over market movements, albeit with scattered success, is the pharmaceutical industry. Global interest in pharma may never have been higher as a result of its potential to free up economies with new tools to battle the spread of the virus. While encouraging results for one pharma company do little to directly affect index values, the sentiment swings and resultant market movements can be compelling, demonstrated by Moderna’s vaccine news last week. Sentiment turns on a dime in these markets and pharmaceuticals have had a pocket full of them.

The pharma products that are being developed to combat the coronavirus can broadly be split into three categories: diagnostic instruments, treatments and vaccines. Progress in any of these areas bode well for the recovery of the economy. Diagnosis allows governments to implement more precision in their policies to stem the viral spread. Effective treatments lessen the load on emergency care facilities and should reduce the death rate, providing more capacity for higher infection rates. A vaccine is the holy grail and maps the route back to normality, provided it is scalable.

As Figure 1 shows, since the start of the pandemic, the global pharmaceutical sector has performed extremely well in comparison to the S&P 500 market, galvanised mostly by the momentous performance of a small number of companies. In particular, the biotechnology sector has outperformed even the FANG+ stocks which have shocked the world with their rapid recovery. Biotechnology focuses on medicines derived from living organisms, which is naturally more geared towards vaccine creation, suggesting a significant amount of the sectoral value creation has been developed in vaccine candidates and testing. The heft of the 10 FANG+ stocks should not be discounted, as the combined market value currently stands at $5.5T[ii] while the whole of the MSCI World Pharma, Biotech & Life Sciences index weighs in at $3.6T[iii]. Regardless, the contributions that pharmaceuticals and biotech have made to the recent stock market rally are notable, even before economic implications and sentiment shifts are accounted for.

Figure 2 exhibits the market performance for the business days surrounding big positive global pharma news since the start of the crisis. So far, these have all coincided with upward swings in momentum in the S&P 500, regardless of other news at play. While we only have a limited number of events to analyse, the sheer prevalence of pharmaceutical news in the financial press would support the conclusion that the effects on sentiment from news on coronavirus combatants are vast. The sentiment ties and strong industry performance together have meant that the correlation between global biotech and the S&P 500 has risen significantly since the start of the crisis, even on a relative basis, and what may come as a surprise is that it has risen even more than the correlation between the FANG+ stocks and the S&P 500[v].

The purpose of this article is not to encourage or discourage readers to invest in biotech. On the company level, finding treatments is an inherently risky business and on the sector level, it is difficult to say whether there is much more value to be extracted. However, what is clear is that if investors want to better understand and predict market movements in this crisis, then they should be keeping one eye fixed on the pharma industry and its developments as it currently has the power to move markets.

[i] The NASDAQ Composite Index was priced at 9,375.78 on May 20^th, 2020 according to Infront Finance data.

[ii] https://www.theice.com/fangplus, Market cap data as of close of business 21/05/2020 from Bloomberg

[iii] https://www.msci.com/documents/10199/ecd9bc5a-b100-4ff8-bfae-3e7340d04631

[iv] Hydroxychloroquine: On April 4^th, Donald Trump advocated for the drug and pressured health agencies to make it more available (https://www.reuters.com/article/us-health-coronavirus-usa-guidance-exclu/exclusive-pressed-by-trump-u-s-pushed-unproven-coronavirus-treatment-guidance-idUSKBN21M0R2)

Moderna vaccine: On May 18^th, Moderna announced that the phase 1 trials of their market-leading vaccine had shown positive results (https://investors.modernatx.com/news-releases/news-release-details/moderna-announces-positive-interim-phase-1-data-its-mrna-vaccine)

Remdesivir: On April 29^th, Gilead Sciences announced that they had received positive results from their drug that suggested it shortened the symptomatic period (https://www.gilead.com/news-and-press/press-room/press-releases/2020/4/gilead-announces-results-from-phase-3-trial-of-investigational-antiviral-remdesivir-in-patients-with-severe-covid-19)

Roche & Abbott antibody tests: Starting on May 3^rd,  Roche and Abbott Laboratories received a series of antibody test approvals from public health bodies, verifying the accuracy of the products (https://www.roche.com/media/releases/med-cor-2020-05-03.htm)

[v] The daily returns correlation coefficients (with the adjusted R squared values in brackets) between MSCI World Biotechnology & the S&P 500 from 3^rd February, 2020 to 21^st May, 2020 was 1.15 (R^2 = 0.83). The equivalent for the NYSE FANG+ index was 0.87 (R^2 = 0.78). The respective correlations for 1^st February, 2019 to 31^st January, 2020 were 0.51 (R^2 = 0.40) and 0.45 (R^2 = 0.65). Source: Bloomberg.

 

 

By Tim Sharp, Hottinger Investment Management

An extreme deterioration of fundamentals amid the COVID-19 pandemic would suggest that the global economy is currently in recession. A strong rally in equities over the course of the last 6 weeks has seen investors ignore the current environment and focus on the ability of companies to hit 2021 / 22 earnings projections. We remain defensive reflecting the on-going fundamental outlook for growth and earnings as well as the concentration in technology stocks once more leading the market. It may be true that these companies have benefitted from the lockdown environment and the take-up of cloud services has accelerated, but valuations are now looking stretched.

The difference between winners and losers is extended and although equity investors are eternally optimistic some of the comments in the financial media justifying the full valuations of technology companies is very reminiscent of the 1999 / 2000 technology rally in our opinion. It is true that growth stocks tend to have lower debt so are less likely to suffer from credit defaults and offer protection from a slow return to normality, however, it is going to be difficult for equity markets to push higher when many traditional sectors, most significantly financials, have not participated.

Many countries are focusing on the reduction in new cases and deaths due to Covid-19 and the move towards re-opening economies. As most European and Asian countries relax stay-at-home protocols and many US states re-open, some despite seeing no flattening of the infection curve, attention moves to tracking signs that lockdowns have been lifted too soon through a resurgence of the virus. Morgan Stanley make the point that once governments have lifted restrictions it is going to be very difficult to go back to full lockdown from both a country and individual perspective[i]. Therefore, many are looking at the Swedish experience to social distancing as perhaps the model for the future having remained partially open throughout the pandemic.

To us, this sounds like a gradual move forwards, containing virus hotspots as they appear, as well as increased testing, leading to a U-shaped recovery rather than the more optimistic V-shaped recovery that has fueled the equity rally. The strength and depth of government support has led many to believe in a shallower recession, but it may also make governments slow to react to a second wave.  There remains a risk that should there be a second wave of the virus caused by the early lifting of lockdowns, the global economy suffers a W- shaped, double dip recession. ASR further write that this bear market is a multi-factor crisis bringing together a biological shock, an oil shock, a credit shock and an economic shock and as such, may well see a multi-phase recovery with economic uncertainty that is currently underestimated[ii].

At the time of writing equity markets seem to have stalled as the realization that the economic recovery is going to be gradual and the risk to future earnings estimates is real. Market technicals also point to a major resistance level on the S&P500 at 2950-3020 and the index has backed away from that level over the last couple of days pointing to potential weakness in stock markets in the very short term. A potential catalyst to push markets higher may come from a rotation into deep value sectors such as Energy, Materials and Banks, but, many traditional sectors have not experienced such moves as investors continue to shy away from areas of the economy that have been substantially affected by the pandemic.

Major companies have been a significant support for stock markets through buybacks, and signs that programmes have been halted or scaled back, due to falling earnings, will remove a major buyer from the market. ASR believe that corporate earnings will take longer to recover than markets expect having seen earnings take two years to recover after the global financial crisis in 2008 and, therefore, 2021 earnings estimates remain unrealistic[iii].

In terms of asset allocation, we continue to believe we are seeing a strong bear market rally with insufficient fundamental information to establish a growth or earnings trajectory. Therefore, we remain mindful of a second equity drawdown that may re-test the lows depending on the signs that economies have opened too early. Positioning remains defensive with underweights in equities and corporate bonds in favour of cash. Finally, the poor starting point for government bonds, with yields so low, means investors do not receive a real return but this should not detract from the natural hedge that ten-year government bonds offer against equity weakness for multi-asset investors. Actively managing duration may be a better strategy than ignoring the negative correlation this relationship offers.

 

[i] Morgan Stanley Sunday Start – U is for Unicorn; May 10, 2020

[ii] ASR Investment Committee Briefing for May 2020.

[iii] ASR’s Ian Hartnett, CNBC’s Squawk Box Europe, May 14, 2020

By Tim Sharp, Hottinger Investment Management

The Covid-19 crisis has in many ways been unprecedented and aside from the human tragedy that has unfolded the effects have been very difficult for economists and investors to forecast with any degree of accuracy. As we have pointed out in previous articles, comparisons to previous crises have proven mixed because there has not been a global pandemic since the Spanish flu outbreak in 1918 and globalization and technology have changed society significantly since then.Many investors have decided that the 1st quarter reporting season is largely irrelevant because the fact that the world is in recession and companies are in lockdown is already known. The important issues are whether balance sheets are strong enough to withstand this cessation in activity in a manner that will allow them to meet 2021 and 2022 earnings estimates.

Many companies have turned to governments for help with emergency funding, others have gone to the corporate debt markets with new issuance and many bellwether companies are being questioned as to whether the disruption to operations poses a meaningful risk to balance sheet strength. Visibility over future profits has disappeared as companies suspend guidance for the year leaving investors to try and figure out what the global economy may look like in the medium term.

The shape of the recovery becomes key to the ability of society to return to normal or a new normal and companies to meet future earnings estimates. The ferocious sell-off in stock markets in February / March followed by an equally unbelievable recovery by certain sectors point to a belief by many in a V-shaped recovery. However, the economic forecasts suggest perhaps a U-shaped recovery or even worse an L-shaped recovery, not to mention a W-shaped or even theoretically a J-shaped (or Nike “whoosh”) recovery. But what does this mean and to what does it translate in real terms?

The shapes of recessions principally relate to the shape created by a basket of economic measures used by economists to measure a recession when plotted on a graph. The much talked about V-shape recession is characterized by a sharp economic decline followed by a quick and sustained recovery. In other words, the economy will quickly return to normal once the virus recedes with no lag or loss of momentum much the same as often seen following a natural disaster such as a hurricane or floods. If this crisis follows this path, then we would expect to see the unemployment rate that has spiked so strongly fall back just as quickly as economies re-open and people return to work. We would also expect economic activity to return immediately to pre-crisis levels as pent-up consumer demand is satisfied and pre-pandemic activity resumes.

Absolute Strategy Research (ASR) point out some differences between natural disasters and pandemics most notably that natural disasters tend to be geographically isolated events rather than having a synchronized global effect. Furthermore, natural disasters tend to provide an immediate stimulus to the economy as society physically rebuilds whereas pandemics tend to suffer a demand and supply shock through the quarantining of the population that depresses the possibility of output to recover its previous peak . We tend to agree that a V-shaped recovery looks unlikely and it will be a slow, cautious return of activity over a prolonged period.

The Global Financial Crisis (GFC) of 2008/09 caused a recession through damage inflicted on the financial sector through extended activities that were conducted “off-balance sheet” in what became known as the shadow banking sector. ASR reminds us of the rule that downturns which coincide with a financial crisis tend to be deeper and longer lasting than otherwise[i]. An L-shaped recovery is, therefore, characterized by a steep decline caused by plummeting economic growth followed by a shallower upward slope, indicating a long period of stagnant growth that can sometimes take several years to recover [ii]. We hope that the recovery from Covid-19 does not take 5 years or more to recapture its previous strength, but this may depend on the level of defaults seen within the corporate sector[i]. The levels of corporate debt have spiraled in recent years as companies have taken advantage of cheap finance to restructure their balance sheets and buy back shares. Therefore, the robustness of corporate balance sheets combined with the support provided by governments and central banks may hold the key to the strength of the recovery [ii].

ASR calculate that households appear to have significantly increased their savings since the start of the pandemic, which may be a sign that spending habits have permanently changed but is more likely to be the result of an inability to follow normal spending patterns due to the lock down. Although, consumption opportunities not taken will probably be lost to the economy it is likely that household spending could support a recovery[i].

The 1973 Oil shock caused rapidly increasing oil prices and led to the 1973-1974 stock market crash that affected most stock markets and economies in the developed world. Developed economies turned down in 1973 showing only slight signs of growth before recovering again in 1975 in what is often described as a U-shaped recover[ii] .

The current situation could also resemble a U-shaped recession if the steep decline into quarantine does not create a depression (L-Shape recession) with the return of a slow, cautious reappearance of economic activity over the next 18 months.

As governments start to formulate exit strategies and economies begin to re-open, should a V-shaped recovery take place then we fear that the acceleration to normal activity in the very short term could precipitate a second wave of the virus bringing us to a W-shaped recession.

A W-shaped recovery, often called a double-dip recession, is when an economy passes from recession to recovery and immediately turns back down into another recession which can be particularly painful for investors that are drawn in too early into financial markets by the swift recovery in activity.

The unprecedented relief offered by governments and central banks have underpinned the real economy in the short term and led many investors to bet on a V-shaped recovery in activity. For our part we favour a U-shaped recovery but as countries rush to re-open even though new outbreaks are still occurring, we fear a second wave of the virus in the autumn creating a W – double dip recession.

Policymakers may need to ensure that they follow up their initial support with additional relief measures once the economies have re-opened and the size of the challenge that lies ahead becomes more evident. The effectiveness of the economic and humanitarian policies in place for the next phase may well decide which shape the Covid-19 recession-recovery resembles.

 

[i] ASR – What shape will the recovery be? – Dominic White / Ben Blanchard – May 5, 2020

 

[ii] Investopedia – A Guide to Economic Recession – Jim Chappelow – April 20, 2020

By Kevin Miskin, Hottinger Investment Management

Ben Bernanke, former chairman of the US Federal Reserve (Fed) once said, “I’ve never been on Wall Street. And I care about Wall Street for one reason and one reason only because what happens on Wall Street matters to Main Street.”

During April, economic data confirmed that the US and Europe had entered recession and global activity was in freefall. This dismal scenario was corroborated by government bond markets where the benchmark US and UK 10-year yields posted their lowest monthly closes on record (0.64% and 0.23%, respectively) and the German bund yield slipped further into negative territory. Meanwhile, there was hiatus in the oil market where futures briefly turned negative for the first time in history due to the sharp fall in demand. Yet, in equity markets, April was the best month for the S&P 500 since January 1987, while FTSE All World index of global stocks recorded its best month since 2011. The question is, in this challenging climate, can Main Street take solace from the recent activity on Wall Street?

The International Monetary Fund (IMF) did not pull any punches mid-month with its view of the economic consequences of Covid-19 when it said the loss of output globally would “dwarf” the global financial crisis of 12 years ago, with most economies emerging 5% smaller than planned, even after a sharp recovery in 2021[i].

The economic data, thus far, would tend to support the IMF’s forecasts. In the US, gross domestic product fell by 4.8% in the first quarter and the virus has claimed 30 million jobs to date, which has resulted in a sharp decline in retail sales. Fed chair Jay Powell has warned of “considerable risks to the economic outlook over the medium term”.

It was a similar picture in Europe where the economy shrank by 3.8% over the last quarter, the fastest pace on record, with France posting its worst decline since 1949. Meanwhile, in the UK, the Purchasing Managers Index of service sector activity, which represents 80% of the economy, plunged to 12.3 in April having been comfortably above the expansionary watermark of 50 just two months prior.

Having been quick to respond to the onset of the economic downturn in March, central banks extended their list of policy actions further in April. The Bank of England started to finance the government directly, effectively increasing the latter’s account by an “unlimited amount”, thereby bypassing the process of quantitative easing whereby it buys gilts issued by the government.

Meanwhile, the US and European central banks made their first ever forays into the non-investment grade corporate bond market. They will allow themselves to buy the bonds of “fallen angel” companies, or companies that are downgraded from investment grade to junk. An immediate beneficiary was the Ford Motor Company, which having been downgraded to junk status in late March made the cut for the US programme by one day. More broadly, the pledges to buy riskier corporate bonds effectively placed a floor under the credit market and provided investors with a reason to buy, safe in the knowledge that the Fed and ECB had their back, without the banks themselves having to spend a cent.

For its part, the Bank of Japan (BoJ) removed the limits on its purchases of government bonds to allow it to exercise “yield curve control” by anchoring the 10-year yield at zero. TwentyFour Asset Management caution that the BoJ’s actions could be a prelude for other central bank actions. They believe the huge amount of issuance coming down the tracks to fund the enormous fiscal expansion could be inflationary and deter real money investors from buying longer-dated maturities given the paltry yields on offer[ii]. That would leave central banks as the dominant buyers with the long-end of the curve becoming not only risk-free, but return free, thereby pushing investors further towards the credit and equity markets.

April brought the first batch of US and Pan-European company earnings reports since the outbreak of coronavirus. By-and-large markets were primed for disappointing numbers as analysts had already been quick to cut estimates to 2008-09 levels, according to Barclays[iii]. With almost half of US and European companies having reported, earnings growth has been the lowest in a decade. Credit Suisse forecast that US companies’ earnings are on track to fall by 16% for the first quarter and may not fully recover for years[iv].

Within the banking sector, the central theme was billions of dollars being set aside for loan loss provisions, USD50bn being the latest estimate across the US and Europe. Consumer stocks including Adidas, Coke and Unilever reported sharp, often double-digit, declines in sales. Dividends were cut or suspended; Royal Dutch Shell cut its dividend for the first time since the war and the largest UK banks suspended payouts for this year and next, although the decision had effectively been made for them by the Bank of England. There were bright spots within the technology sector where companies such as Netflix and Microsoft were beneficiaries of the transition to working and being entertained from home; Satya Nadella, CEO of Microsoft, noted that two years of digital transformation had occurred in two months[v].

Nevertheless, almost across the board, companies were unable to provide guidance for future earnings. It is often said that “markets hate uncertainty”, therefore it was somewhat surprising that global stocks rallied to the extent they did. Clearly investors are more concerned with companies remaining solvent in 2020 and are looking to a brighter 2021.

Benchmark equity indices gained between 4% and 6% in the UK, Europe, Japan and China. However, it was the performance of US stocks that stood out with the S&P500 gaining 13%. If ever there was a reminder that the S&P500 has five names (Microsoft, Apple, Amazon, Facebook, Alphabet) making up 20% of the index, rather than a clearer representation of the real economy, this was it.

Following the latest leg-up in equity markets, valuations look rather rich. The MSCI Europe index is trading on a 15.2x forward price-to-earnings multiple, which is higher than its pre-COVID-19 crisis level. Meanwhile, the S&P 500’s forward multiple has risen to 20.1, well above the previous peak in February and now the highest it has been since April 2002. In terms of style, Quality and Growth stocks have become almost the most expensive on record while the more economically sensitive Value stocks trade at historically cheap levels. This would suggest investors are assuming that government bond yields are going to remain at or around zero for the foreseeable future and earnings are going to recover later this year or next.

We remain cautious. Bear markets have a precedent for luring investors back in too early. The world is amid a sharp slowdown and the full drawdown on corporate earnings has yet to be established. Further, the equity market rally that started in late March has been driven by liquidity rather than fundamentals.

On a positive note, at the time of writing, lockdown measures are starting to be eased to varying degrees around the world, which is a first step towards recovery. Yet, it is too early to know whether the quarantine measures enacted thus far will prove sufficient to suppress the spread of the virus, or whether further periods of containment will be required until a vaccine becomes available.

Even once the lockdown has been eased, global growth could remain subdued for a while and we anticipate a more moderate return towards normality than the V-shaped recovery currently being priced-in by equity markets.

 

[i] Financial Times, “Global economy to suffer worst blow since the 1930s, warns IMF”, 14^th April 2020

[ii] TwentyFour Asset Management, “The Beginning of The End For Government Bonds, 27^th April 2020

[iii] Barclays, “Result Snapshot – Not bad enough”, 30^th April 2020

[iv] Financial Times, “US stocks close out best month since 1987 in global rebound”, 30^th April 2020

[v] Microsoft.com “2 years of digital transformation in 2 months”, 30^th April 2020

 

 

By Laura Catterson, Hottinger Investment Management

“The ballot is stronger than the bullet” ― Abraham Lincoln

If you are at all familiar with US presidential elections, you will understand that in attempting to outlay the hurdles a voter may encounter, one can never be terse; therein lies the rub.

2020 is particularly vulnerable. This election season is confronted by this generation’s global pandemic. COVID-19 is poised to upend US citizens ability to cast their ballot unless voting by mail can resurrect a far from auspicious system. Evidence from states who have already implemented this method suggests it works well if preparations are made early and potential obstacles are foreseen, the largest of which are logistics and time. Thus, in order to save democracy’s most sacred institution, officials at all levels of government must make hay while the sun shines, and sleeps for that matter.

If you are eighteen years old, a US citizen and resident in one of the fifty states, assuming you are not a felon; you are eligible to vote.[i] Today, the pool of eligible voters is far broader and more inclusive than ever before; yet imperfection remains. Gaining access to the ballot box has been made more difficult by active efforts to suppress some groups from voting. These tactics, wrapped in a veneer of law include: voter intimidation, criminalization of voter registration drives, disguised poll taxes, gerrymandered districts (where the boundaries of an electoral constituency are manipulated to favour one party), hackable voting machines, voter poll purges and squashing access to voting on college campuses.[ii] Voter ID laws are also an extremely effective way of voter suppression. Over twenty-one million US citizens do not have a government issued photo ID which as a result, reduces voter turnout by two to three percent.[iii]

This year’s election, however, is unlikely to look like any other. Should COVID-19 persist, the need to keep people separated will present an unprecedented challenge in holding a nationwide vote.[iv] The potential risk of contagion at polling stations means a reliable alternative is key. Now backed by two thirds of US voters, voting by mail could be the required remedy.[v]

The urgency of implementing this method en masse, however, is becoming ever greater. At the time of writing, COVID-19 has forced fifteen states to postpone their presidential primaries or switch to voting by mail with extended deadlines.[vi] The general election in November however, a date prescribed by law; cannot be postponed, followed shortly by the constitutionally mandated inauguration of the next president on 20th January 2021.[vii]

To ascertain whether voting by mail is a viable option nationwide, we must examine current state examples and assess the logistical framework required for November. Colorado, Hawaii, Oregon, Utah and Washington represent the five states where most or all votes are cast by mail. Their experiences have yielded the following key findings: voter turnout is significantly higher, it is safe and secure and lastly, voters of all political persuasions use it and like it which is a milestone in and of itself. [iv]

During the 2016 election, nearly one-quarter of all voters cast their ballot by mail and as figure 1 highlights, it is steadily growing in popularity.

These findings are encouraging however, expanding this method nationwide in a matter of months is a herculean task and one which needs to begin today.

At a minimum, the following is required: printing tens of millions of mail-in ballots and envelopes; ensuring registered voters automatically receive one; can request a replacement if they do not; and can return it by election day.iv Additionally, in states where voting by mail is relatively low, they are typically not equipped with machines that can scan mail-in ballots on mass. Thus, administrators currently compare signatures on mail-in ballots against those on file in the voter registration database. If these states are to expect a spike in mail voting this November, more staff need to be trained, voter registration simplified, and technology upgraded. The latter of which can only be implemented if the limited number of vendors who can perform such a task are not already constrained by a sharp increase in demand.[vii]

Further provisions that must be made include public education on handling and returning ballots, as well as nationwide early voting availability so that should a person be uncomfortable or unable to vote by mail, they can do so in person whilst social distancing policies are still adhered to.

Reassuringly, efforts are already being made to implement many of the above measures. Senator Amy Klobuchar and Senator Ron Wyden have designed a bill to combat the implications of COVID-19 and any future diseases or natural disasters which cause similar disruption. The bill specifies, should 25% of states declare a state of emergency, mail-in or drop-off paper ballot options must be made available and that requests for a ballot can be made electronically. The bill would also provide the necessary funding for states to implement such measures.

This is promising however, it would be foolish to suggest implementing every necessary measure, nationwide, without error and within a matter of months, is achievable. Nevertheless, the US government has responded to the threat COVID-19 has had on the economy and the health of the American people and it is crucial it responds to the threat on democracy in kind.

Looking ahead, it is likely voter suppression will remain for years to come however, it is evident that with the expansion of voter rights, predominantly voting by mail which once refined across all states, will do much to combat such draconian efforts. Additionally, the fact that this method of voting is liked by both sides of the political aisle suggests its popularity is only set to continue growing as well as the demand for a fairer and more just political system.

For this year however, all that can be done; must be. A country that suffers from some of the lowest voter turnout in the developed world[viii] clearly needs an injection of voter confidence and convenience. Voting by mail provides just that however, democracy has a deadline and the clock is ticking.

[i] https://www.youtube.com/watch?v=P9VdyPbbzlI

 

[ii] https://www.theguardian.com/us-news/2019/nov/13/voter-suppression-2020-democracy-america

 

[iii] https://www.aclu.org/news/civil-liberties/block-the-vote-voter-suppression-in-2020/

 

[iv] https://www.nytimes.com/2020/03/21/opinion/sunday/coronavirus-vote-mail.html

 

[v] https://www.independent.co.uk/news/world/americas/us-mail-voting-november-election-trump-objection-a9479876.html

 

[vi] https://www.nytimes.com/article/2020-campaign-primary-calendar-coronavirus.html

 

Figure 1: eac.gov

 

[vii] https://bipartisanpolicy.org/blog/voting-by-mail-in-the-age-of-coronavirus-a-good-idea-but-not-a-total-solution/

 

[viii] https://www.pewresearch.org/fact-tank/2018/05/21/u-s-voter-turnout-trails-most-developed-countries/