Blog

By Robbie Hubbard, Hottinger & Co. 

For many of us in the UK this year, the term staycation has been a common theme, and this may well be the case for some time yet, especially going into 2021. Over the summer, the uncertainty from the Coronavirus pandemic meant that families opted for domestic trips over international breaks. There has therefore been a surge in UK holidays and bookings have already hit record highs, with cottages and campsites becoming a very popular choice.

Having recently returned from a trip to the coast and the Cotswolds, it was very apparent that our seaside towns and rural retreats appear able to shake the disease and life felt almost normal again, even for a brief while. It was a welcome break during such unprecedented times and an opportunity to appreciate the stunning shores and scenery on our very own doorstep, which is often overlooked in search of warmer climates.

In June, following Boris Johnson’s announcement to lift some lockdown restrictions on self-contained accommodation, many travel sites experienced record bookings; Hoseasons was reporting one booking every 11 seconds![i] With a vaccine still over the horizon, it is unlikely that holidays will return to normal next year, however, the UK’s tourism industry is much less dependent on international travellers than sunnier destinations. Even before the crisis, domestic travellers accounted for 81% of tourism in Britain compared to 53% in Spain and just 30% in Greece[ii].

Britain is one of a handful of European countries to have a tourism spending deficit which amounts to approximately €18.3bn[iii]. In other words, foreign visitors spend less on tourism in the UK than Britons spend abroad and staycation holiday substitutions could result in a much-needed boost to the sector. Statistics from Parkdean Resorts suggest that Britons spend £48bn on summer holidays each year, so with more holidaymakers staying within our shores  £8.24bn extra income for UK tourism could be produced, which equates to £900 per person.[iv] This will also likely largely be felt in the more local and vulnerable parts of the UK economy . Capital Economics write that if the entire £60bn that Britons usually spend on overseas holidays was to be spent onshore then GDP would receive a boost of 2.8% in 2020, offsetting the 1.3% lost from overseas visitors.

There is also evidence that tourism revenues are flooding away from cities to rural and less wealthy areas. The 2020 Staycation Market Report issued by Parkdean Resorts shows popular destinations such as Devon and Cornwall recording bookings up 86% and 33% respectively and the Isle of White up 40%. As a result, many key local destinations are extending their seasons in order to accommodate those looking to take late breaks. For example, Blackpool’s illuminations will be lighting up the seafront until January, and many campsites and holiday homes have extended the season by 4-6 weeks.v  Many Britons that are staying in the UK for their holidays for the first time in many years seem to be using the opportunity to revisit childhood memories of holidays past, returning to coastal towns and areas of natural beauty. On the other hand, the first port of call for foreign tourists tends to be city-based, namely London, Edinburgh, York, and the university towns of Oxford and Cambridge. Research provided by Springboard shows footfall in coastal towns was only down 24.4% in August compared to a year earlier whereas central London was down 64% over the same period and regional cities a slowdown of over 50%[v].

A sense of optimism shines over the UK’s tourism industry during a frankly bleak and unpredictable time. With trips abroad still remaining uncertain, Britons are instead staying closer to home, giving our economy a much-needed boost. Campsites and holiday parks are already seeing soaring bookings for next year, as families look to make the most of the summer holidays in 2021 and make up for lost time. Make no mistake, the statistics suggest domestic spending on holidays and day trips will still fall by half in 2020, down from the £91.6bn spent in 2019v, but tourist boards across the country will be looking to tempt the UK consumer into a well-earned staycation in 2021.

 

[i] https://www.standard.co.uk/lifestyle/travel/uk-holidays/staycation-booking-statistics-england-2020-a4479766.html

[ii] https://www.telegraph.co.uk/business/2020/04/30/britain-set-staycation-boom/

[iii] https://www.telegraph.co.uk/business/2020/04/30/britain-set-staycation-boom/

[iv] https://www.express.co.uk/travel/articles/1310111/uk-holidays-staycation-holiday-in-UK-destinations-devon-cornwall-isle-of-wight

[v] https://www.theguardian.com/business/2020/sep/05/uk-tourism-hotspots-extend-their-holiday-season-to-lure-more-visitors

 

 

 

 

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By Tom Wickers, Hottinger Investment Management 

Last year, news channels continued to berate our eardrums with the 2016 word of the year; Brexit[i]. We experienced a somewhat oxymoronic year where headlines generally highlighted that there was no change and so, no news. Over the Christmas holidays, the withdrawal agreement was eventually passed through the House of Commons and the country came to its first unanimous agreement in a long time; to not discuss it again for as long as possible. COVID-19 has provided news anchors with alternative talking points but as summer has left us, Brexit has raised its ugly head again. Public discontent rescinded at the turn of the year, returning in part with COVID policy displeasure [Figure 1]. The government will likely be mindful to keep an eye on these figures as Brexit frictions return to the fore.

September is a big month for negotiations and strong rhetoric has already begun to mount. Today, ministers have announced that they are drafting legislation to remove arrangements made in the withdrawal agreement and Boris Johnson is expected to brief all parties that the 15^th October should be the deadline for any agreement. Time is short, yet large and stubborn divisions remain between the two sides and currently Michel Barnier and David Frost are busy playing the blame game, accusing one another of being unreasonable[iii].

Fishing waters aside, the sticking point revolves around sovereignty, put simply the UK wants it in full and that concerns the EU. The Conservative Party houses several powerful players, such as Dominic Cummings, who are keen advocates for independence and hence the government does not have much wiggle room on its position. The EU cannot agree any significant deal with a country in close proximity that is effectively threatening to compete on taxes, subsidies and ethics, or would risk undermining its member countries and existing trade partners. The rift is large and neither Mr Frost nor Mr Barnier seem willing or able to bridge the gap. To provide some context for the gamblers among us, bookmakers currently have the odds of no trade deal being agreed in 2020 at 4/7[iv] and the most likely scenario by some way is one with no delay and no deal.

The chance of no deal being agreed in 2020 is considerable and is getting larger. Should Boris Johnson stick to his word and not agree to a delay[v], lack of progress in the next two months will mean the UK separates from the EU on WTO trading rules. For some, it is a small price to pay for our sovereignty, for others it is a catastrophe that will cause many economic frictions going forward. There will be those who are confident in the UK’s ability to negotiate better economic fortunes in new geographies to compensate for the economic damage from loss of trade with the EU. Nonetheless, recent economic studies still provide an important base case scenario of what we may expect for our economy following COVID-19 and a no-deal Brexit.

The Bank of England (BoE) forecasts a 9.5% contraction in GDP this year as a result of the COVID crisis[vi], the likes of which we have not seen for 100 years. A blip from a no-deal Brexit has therefore been argued to be menial by some. Comparing the events over a longer term unfortunately yields different results. The BoE currently predicts the permanent scar from COVID-19 to be in the region of a 1.5% reduction in GDP[vii] from its long-term trend. Similarly, roughly half of the major economic forecasts for a Brexit with a WTO trading-scenario knock 2% off UK GDP in relation to a Free Trade Agreement[viii]. A combination of the two could have compounding effects as fiscal policy loses its spending power, resulting in a difficult road ahead for our economy.

Tough talk is a must when trying to negotiate a good deal. Nevertheless, the increasing risk of no reconciliation will have many economists flustered. The government and UK economy may yet surprise the majority of forecasters with impressive foreign policy and innovation, but the base case is dour. We will be keeping a close eye on the negotiations in the coming weeks, beginning with the eighth-round tomorrow.

 

[i] https://www.collinsdictionary.com/word-lovers-blog/new/top-10-collins-words-of-the-year-2016,323,hcb.html

[ii] https://whatukthinks.org/eu/questions/how-well-or-badly-do-you-the-government-are-doing-at-negotiating-britains-exit-from-the-eu/

[iii] https://www.ft.com/content/f798a3a0-1ce3-4082-8780-6f172f70779e

[iv] Odds taken as of 07/09/2020  https://www.oddschecker.com/politics/brexit

[v] https://www.foxnews.com/politics/boris-johnson-brexit-delay-coronavirus

[vi] https://news.sky.com/story/coronavirus-uk-to-nosedive-into-recession-after-covid-19-triggers-record-slump-12047281

[vii] https://news.sky.com/story/coronavirus-damage-to-economy-may-be-worse-than-feared-bank-of-england-rate-setters-warn-12061817

[viii] Original source: Institute for Government. Assesses only the economic houses that provide predictions for both a World Trade Organisation trading scenario and a Free Trade Agreement trading scenario. https://www.ft.com/content/4440f83d-7e8a-4510-b8b7-3fb9146da51a

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By Kevin Miskin, Hottinger Investment Management 

In a month when the highest ever temperature on earth of 54.4 degrees celsius was recorded in Death Valley, California, demand for technology stocks across the way in Silicon Valley continued to heat up.

The five big technology platforms—Alphabet, Amazon, Apple, Facebook and Microsoft— all posted double-digit gains to help drive the Nasdaq higher by 9.6% during August, thereby outperforming the broader S&P500 (+7.0%) and the MSCI World Index (+6.5%). Apple reached a market capitalisation of $2trn, the first American company to do so. It took 38 years for the company to reach the $1trn mark and just two years to double that, according to Barclays.

Strong demand for technology stocks has sparked the IPO market back to life in a flurry of activity not seen since the dotcom bubble.  ‘Unicorn’ companies reportedly filing for IPO include Airbnb, Snowflake Computing, DoorDash and Instacart. Add-in Palantir, a cryptic data-management firm preparing for a direct sale, and the estimated valuation of these five is $80bn, according to PitchBook [i]. Yet, none of Silicon Valley’s upcoming listings rival that of Ant Group, the payments arm of Alibaba, which has cried ‘open sesame’ to investors’ wallets with plans to raise a record $30bn, which could value the firm at around $200bn.

With the IPO market resurgent, the Nasdaq having gained almost a third year-to date and the S&P500 making all-time highs, there has been talk of whether the equity market is in the realms of “irrational exuberance”. Certainly, there has been a lack of breadth to the recent rally; the five big technology platforms having accounted for a quarter of the S&P500’s rally since March. They also represent more than a fifth of the index, the biggest weighting for the top five since at least 1980. Notably, the majority of S&P 500 constituents are still below their levels when the market last peaked on 19th February.

In terms of valuation, US stocks are now priced at more than 22 times forward earnings, according to FactSet, representing levels not seen since the dotcom bubble burst two decades ago. Yet, the composition of the S&P500 index has changed considerably since 1999 when its largest components consisted of GE, Exxon, Pfizer, Citigroup and Cisco. Therefore, it is not surprising that the shift to high growth technology stocks has resulted in a higher valuation. Further, as a result of the sharp decline in bond yields, US stocks compare well on a relative basis; the earnings yield on US stocks is 3.8% versus a yield of 0.7% on the 10-year US Treasury, representing a gap slightly above the long-term average [ii].

With the dust having settled on Q2 reporting season, earnings revisions have turned positive according to Barclays Bank, which has also buoyed investor confidence. Greater visibility from the impact of Covid-19 has led to a slightly improved tone from companies. Cost cutting coupled with nascent signs of an economic rebound should help the earnings recovery during the rest of the year, so the theory goes. Nevertheless, weekly initial US jobless claims rose back above one million for two consecutive weeks at the end of August and the recovery in mobility traffic and other high-frequency indicators has eased. Further, the Vix volatility index has decoupled from equity markets, which has previously been a signal of trouble on the horizon [iii]. Therefore, we retain some caution.

Whilst US stocks ended August in positive territory for the year, most other equity markets remain negative. European stocks gained 3.1% during the month but remain under water by 11% for 2020. The German Dax Index has been exceptionally resilient, briefly turning positive during August, assisted by strong returns from technology stocks Infineon and SAP, together with logistics company DHL Deutsche Post.

Japanese stocks gained 8.2% during August, despite suffering a set-back at the end of the month, following the resignation of prime minister Shinzo Abe due to ill health. During his eight-year tenure, the Topix index has produced a total return 85% in dollar terms, underperforming the S&P 500 but significantly outperforming both the MSCI Europe and MSCI Emerging Market indices. Since Mr Abe’s election, the dividends of Japanese companies have doubled and buybacks have quadrupled, according to Jefferies [iv]. Japanese stocks could be fragile in the short-term until Abe’s successor is instated but initial market consensus is that some form of Abenomics will ultimately prevail.

The FTSE100 index (+1.1%) was the laggard among the major indices in August, held back by the Oil & Gas and Banking sectors. Whilst it was a quiet month for earnings reports, HSBC unveiled an almost seven-fold jump in reserves set aside for bad loans and a steep drop in Q2 profits.

FTSE100 companies, which make two-thirds of their earnings from abroad, were not helped by the strength of sterling which gained 2% versus the US dollar to 1.3353 and 1% versus the euro to 1.1215. Although the UK economy suffered one the sharpest falls in gross domestic product (GDP) among the developed economies in Q2, recent data suggest it could experience a record-breaking recovery in the current quarter. City of London economists forecast GDP will rise by 14.3% in Q3, which could result in the UK moving to the top of the G7 performance table, having propped it up in Q2. The rebound is being driven by the consumer; according to the Office of National Statistics, retail sales in July were 3.6% higher than June and an improvement from a year earlier. Of course, several factors could impede the recovery, not least the winding down of the furlough scheme and a second wave of the virus.

Increased optimism surrounding economic growth not only lifted equity markets but sovereign bond yields as well. The benchmark 10-year bonds yields in the US and UK rose by c. 20 basis points to 0.72% and 0.31%, respectively, and marked their highest levels in two months.

The main development in the fixed income market came from the annual ‘Jackson Hole’ economic symposium. US Federal Reserve Chairman, Jerome Powell, announced that the US central bank will tolerate higher inflation in future as part of its longer-term review of monetary policy. This is a significant development as, in effect, the Fed will now target an average rate of 2% over time allowing it to run with a rate above 2% to compensate for periods when it has been below [v]. As a result, short-term rates should remain lower for longer and the yield curve should steepen, which could be a catalyst for value stocks to outperform in equity markets. Further, if borrowing costs are going to remain anchored and the Fed is encouraging inflation, then the real cost of debt will be eroded which should encourage corporate America to raise capital expenditure.

Of course, inflation would need to pick-up first and only once in the past five years has the Fed’s preferred inflation gauge, the core Personal Consumption Expenditures rate, risen above its 2% target. Nevertheless, the Fed has made its intentions clear and we will watch closely.

 

[i] The Economist – Initial Public Offerings are back in Silicon Valley; August 22, 2020

[ii] FT.com – The uneven rally that took US stocks to a record high; August 18, 2020

[iii] The Felder Report – The VIX is raising a red flag for the rally; August 26, 2020

[iv] FT.com – Investors in Japan lament the departure of ‘Abenomics’ architect; August 28, 2020

[v] Axa IM – Word up; August 28, 2020

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By Alastair Hunter, Hottinger Private Office

The travails of the health and education sectors have been well tabulated through the myriad of media outlets since the onset of the Covid 19 pandemic with a bright light shone on the challenges that the staff and users have faced.  Clearly, these sectors have borne the brunt of this terrible virus.

That said, the impact of the virus extends across the economy and has been keenly felt in the hospitality sector, a sector that in all probability touches us on a daily basis, with potentially long-term ramifications for the well-being of our nation.

If you travel into the centre of any village, town or city, a number of once thriving and bustling eateries, bars, coffee shops and the like simply aren’t trading any longer.  As someone who has worked in London for over 20 years and was always struck by the buzz of our thriving capital city, it has been a vastly restricted city both during and after lockdown.

I am sure this is the same up and down the country. It prompted me to think about how much time I spent frequenting the hospitality sector, for business, family or wider leisure time.

It was quite interesting to look at the different definitions for the hospitality sector – the one I liked was “a range of businesses and services focused on leisure and customer satisfaction”.  Leisure and satisfaction are fundamentally important to us all. As social distancing restrictions have been imposed across society for sound scientific reasons, they have hugely curtailed the ability of the hospitality sector to service our leisure needs.

More than ever we require and desire a sense of escapism that the hospitality sector in part provided. Not only has the sector benefited us all as consumers, but it has also become a major cog in our economy. It surprised me greatly to learn that the hospitality sector by certain estimates is the 3rd biggest employer in the UK, accounting for 3.2m jobs through direct employment in 2017, and a further 2.8m indirectly. The industry generated over £72bn directly to the UK economy, and a further £86bn indirectly[i].

The multiplier effect is a well-known concept within economics, and my suspicion is that the hospitality industry is a key industry for the morale and discretionary spending across the nation. A 2015 study by Oxford Economics suggests that for ‘every £1 million the hospitality industry contributes to GDP itself; it creates another £1.5 million elsewhere in the UK economy’[ii]. Given that it is concerning to see some of the reports over the recent weeks about the lack of velocity of money and low consumer confidence.

On the assumption it has been a difficult time for us consumers, one can only imagine what it has been like for staff and owners of businesses across the sector. What has life been like for the expats, here to work in the bars and explore our great country? The student using the hospitality sector to supplement their studies, or the talented and passionate specialists in the sector working crazy long hours in the establishments, furloughed at best, with their long-term future uncertain and unknown.

Some political credit seems to be due to Rishi Sunak and his “eat out to help out” scheme – as with many political decisions of late, it was largely treated with scepticism across the media but if the figures from Barclaycard and others this week are accurate this would seem to a very well-aimed shot in the arm for a sector that has been very hard hit[iv].

But more needs to be done, as this wonderful weather which has by and large prevailed over the lock down period, won’t last forever ( I think I can be confident of saying that!) and the outside spaces that allow for people to eat drink and be merry in a socially distanced manner will be vastly curtailed as we enter the autumn and winter months.  Even if, and that is a giant if, there is a vaccine coming to market the likelihood of it being widely available during 2020 is low.  Therefore, the hospitality sector faces a sustained period of pressure.  Let’s hope all the political groups can put their thinking caps on and find more successes like the eat out to help out scheme. 35 million people and counting seem to have taken up the opportunity and it is a much-needed stimulus.

Will that 35m people be enough of a catalyst for investors to re-engage with the sector though?  It’s clear the sector is in urgent need of funding and beyond that, many owners will need to show resilience and crisis management skills. Surviving businesses will be those quick to adapt their business models to meet the demands of service in an era of social distancing.

 

[i] https://www.ukhospitality.org.uk/news/408996/130-Billion-hospitality-sector-celebrated-at-inaugural-conference.htm

[ii] http://www.bha.org.uk/nas/content/live/hottingergroup/wp-content/uploads/2015/09/Economic-contribution-of-the-UK-hospitality-industry.pdf

[iii] https://www2.deloitte.com/uk/en/pages/consumer-business/articles/consumer-tracker.html

[iv] https://www.bbc.co.uk/news/business-53699595

 

 

 

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By Tim Sharp, Hottinger Investment Management

At the height of the summer, markets tend to become a little more volatile because of lower trading volumes and our thoughts turn to what is on the horizon. 2^nd quarter earnings saw US companies outperform Europe and mega-tech continues to lead markets. The mix of traditional companies and new probably explains this phenomenon rather than any overriding policy success by the Trump administration. The outperformance of mega-tech can probably be attributed to its many facets – providing the investor with companies that have benefitted from the pandemic lockdown; consistent long-term growth outperformance; significant cashflow generation and minimal debt. The combination of superior growth and defensive qualities has led many investors to continue to support the sector despite expensive valuations.

Conversely, the performance of Europe as it re-opens has caught the attention of investors and may be the catalyst for a rotation into more traditional sectors. Europe went into a strict lockdown that likely resulted in the underperformance in the 2^nd quarter. Policies that have kept workers employed, rather than on subsidised unemployment benefits, have allowed for a stronger re-opening; populations are higher in confidence and more likely to consume and so business confidence has also bounced back strongly. Efficient track and trace systems have allowed for better control of secondary outbreaks such as the latest global increase in new cases. Furthermore, the political agreement on the EU Recovery fund should provide a more stable and predictable platform for monetary and fiscal stimulus instead of meeting resistance at a national level. The banking system remains the backbone of corporate lending in Europe unlike the US where the bond markets are more accessible to small and medium sized firms. Therefore, banks remain key to a sustainable European recovery and, as Absolute Strategy Research (ASR) write, European banks will need to remain good investments[i].

The US Federal Reserve has successfully provided the corporate bond market with support which is probably the reason why high yield and investment grade spreads have not widened in line with the tightening in US bank’s lending standards to corporates, despite an increase in the default rate. This suggests that many companies are being propped up by cheap lending when perhaps their solvency should have been brought into question, creating yet another signal that is being masked by central bank or government intervention.

The rally in gold this year to a peak over $2000 /oz started due to the metals safe haven properties but with near zero interest rates in most of the developed world, a significant drop in inflation rates and, most recently, a depreciating dollar, the gold price has continued to strengthen as an alternative to bonds. But, now that there has been an increase in inflation expectations due to the significant levels of stimulus pumped into economies, the main danger with this strategy is that gold has no protection from inflation either, so when inflation does come back gold may well react in a similar way to equities.

The dollar saw its worst month for about a decade in July losing 4.15% having slowly depreciated against most developed currencies since March. Coupled with the nascent signs of recovery in air freight and shipping container volumes this would point to early signs of a recovery in global growth. Before the pandemic we were exploring the drag on the recovery in global growth caused by a strong dollar, so it is probably no coincidence that this has occurred particularly in Asia where China looks to be the only country to post positive growth in 2020. In March we witnessed the safe haven qualities of dollar ownership at times of stress so we are reluctant to turn away from the dollar when the worst of the pandemic lockdown may yet come to pass as government support starts to be lifted over the coming months.

Judging by recent growth statistics, the UK economy has performed poorly compared to other G7 countries due to a mixture of uncertainty regarding European trade talks and the UK government approach to the pandemic continuing to cause concern. This can also be attributed to much of the UK economy being service sector focused rather than manufacturing. Large swathes of the UK economy remain closed especially in the hospitality, tourist, and entertainment sectors and over 6 million remain furloughed. This has also translated into similar poor returns from UK financial assets leaving them a drag on global, multi-asset portfolios. The UK main indices are also overweight with oil, mining and banking stocks which remain unloved, deep value plays. There are some good UK companies performing very well in growth sectors, but it takes good stock-picking to build a highly valued portfolio rather than passive, index investing.

Finally, we believe that it is unlikely that the world will return to its pre-Covid position and that a new normal will prevail. We have previously commented on the lack of collaboration during the Covid-19 outbreak and we believe that countries will become increasingly isolationist. Should President Trump win a second term, which is an outcome less explored by investors than a Biden win, then it is likely that relations between the US and China will cool further, with the likely complication of competing standards regulating different industries and its inevitable effects on global growth. ASR believe it is also likely that supply chains will shorten, moving from being cost conscious to security conscious[ii]. Companies could look to primarily guarantee production lines rather than cost efficiencies, which may have material effects on the future growth of emerging markets. We have also just witnessed the politicising of a vaccine with the announcement by Russia of the success of their Sputnik 5 Covid vaccine. If successful vaccines are offered in the near future, there is therefore the possibility that they may not be accepted globally without other countries undertaking their own testing. For example, in the current environment it seems unlikely that the US would trust a Chinese vaccine, regardless of how genuine and transparent the testing results are. This was recently referred to by the World Health Organisation as “vaccine nationalism”[iii], and as such, it is probably a good thing in this increasingly isolationist world, that there are so many Covid vaccines being tested globally if it is to be working vaccines that offer the best chance of countries returning to normal activity levels once more.

 

[i] Absolute Strategy Research – “Banking” on Eurozone Equities – August 6, 2020

[ii] Absolute Strategy Research – Investment Committee Briefing – August 7, 2020

[iii] https://www.msn.com/en-gb/money/technology/who-chief-concerned-about-vaccine-nationalism/vi-BB17VKrl

 

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By Kevin Miskin, Hottinger Investment Management

July offered a something for ‘glass half full’ and ‘glass half empty’ investors alike. Politics scored highly for those of a pessimistic disposition as tensions rose between the US and China. President Trump openly expressed his increasing anger with Beijing, which culminated in consulates being closed in both countries as part of a tit-for-tat spat. Matters could deteriorate further in August if the US government calls time on Microsoft’s acquisition of TikTok, having already accused it of being a conduit for Chinese state-sponsored spyware [i]. Meanwhile, Brexit negotiations rumbled on with seemingly little progress, particularly on how to ensure a “level playing field” and access to British fishing waters. In an effort to accelerate the stymied talks, Boris Johnson had called for the two sides to “put the tiger in the tank” — a throwback to the old Esso petrol adverts, but maybe Michel Barnier and his cohorts are driving BWM i3s and Renault Zoes, metaphorically speaking.

Brexit to one side, the EU’s 27 national leaders found fiscal unity, albeit after arguably the coalition’s longest ever summit, to agree the EUR750bn “Next Generation EU” (NGEU) fund to help countries recover from the Covid-19 recession. Most leaders could claim to have gained from the talks; the French and Germans saw their plan approved, the southern states should receive funds worth several points of GDP and the so-called “Frugal Four” countries of The Netherlands, Austria, Sweden and Denmark won concessions [ii]. Symbolically it was a historic moment, similar to that of Mario Draghi’s pledge to do “whatever it takes” to save the euro.

Understandably, the pandemic continued to influence the economic data. The US Federal Reserve (Fed), for the first time in its official statement acknowledged the virus would significantly influence the fate of the US economy [iii]. The closely watched weekly US unemployment claims, which had shown a consistent improvement since March, started to rise in the latter part of the month as the death toll started to rise again. The US also reported its largest contraction in post-war history as the economy shrunk by 9.5% during the second quarter. In Europe, where it is widely considered that the virus has been handled more effectively, the GDP reports were similarly stark. The German economy shrank by 10.1% in the second quarter, thereby wiping out ten years of growth according to Berenburg Bank, while France contracted by a record 13.8%.

In the UK, chancellor Rishi Sunak delivered a “summer economic update” in which he announced £30bn in new measures, equivalent to 1.4% of pre-crisis GDP, for the current financial year. His plans included a £2bn KickStart scheme to provide six-month work placements for the young unemployed, a much-needed cut in VAT for the leisure and hospitality industries and an “Eat Out to Help Out” scheme aimed at helping pubs and restaurants. By and large, commentators were underwhelmed. For example, Pantheon Macroeconomics believes that £30bn will be insufficient to “fill the void” when the furlough scheme ends in October. Yet, it was not all ‘doom and gloom’ as retail sales recovered far more strongly than forecast in June, according to the Office for National Statistics, and Bank of England Governor Andrew Bailey remarked that there were signs of activity returning “quite strongly” in the housing market and in new car sales [iv].

One area of the world that has returned to growth is China where GDP expanded by 3.2% in the second quarter, thereby providing the earliest signs of recovery from the fallout of the pandemic. Nevertheless, on balance the global economic backdrop remains challenging, not helped be emerging signs of a second wave towards the end of the month.

The US dollar, often viewed as a safe-haven currency, dropped more than 4% against a basket of other currencies to post its worst monthly performance in a decade. Several factors are weighing on the ‘greenback’ including outbreaks of the virus in key states (including, California, Texas and Florida) and the upcoming election where Democratic candidate Joe Biden has a commanding lead in the polls. In addition, the euro has gained traction because of the recovery fund mentioned above and other parts of the world are showing nascent signs of recovery. Does all this mean the dollar is under threat as a reserve currency? We suspect not just yet, as it was only four months ago that investors flocked to the dollar for safety.

Meanwhile gold, referred to the currency of last resort recently by Goldman Sachs, gained more than 10% to reach an all-time high. The combination of lower real yields and a softer dollar has provided the perfect backdrop for a major rally in the yellow metal. Some investors are also purchasing gold as an inflation hedge, taking the view that at some point global economies will recover from the pandemic and central banks will allow prices to rise to reduce their debt burden. Nevertheless, talk of inflation was lost in government bond markets as concerns regarding growth resulted in even lower yields; the US 10-year yield edging lower to 0.53% and the benchmark UK gilt yield falling to 0.10%.

With risk-off assets in the ascendancy, it was somewhat unusual that risk-on assets also recorded healthy returns in July. US junk bonds had their best month in nearly nine years as the average yield fell below 6% [v], despite the number of defaults in H1 having exceeded the total for the whole of 2019, according to Moody’s. Further, Moody’s expects the default rate to almost double from current levels, before peaking at 9.6% in Q1 2021, with bankruptcies likely to be concentrated in the Retail, Oil & Gas and Leisure sectors.

Global equity markets appreciated by 4.7% buoyed by a positive US earnings season and nascent signs of a recovery in M&A activity.  Yet, a deeper delve into geographic and sector returns revealed a more mixed picture. China (+12.8%) and the US (+5.5%) led the way while Europe (-1.8%), Japan (-4.0%) and the UK (-4.4%) posted losses. The Chinese market enjoyed strong gains after a widely read, state sponsored securities journal told investors to expect a “healthy bull market”. Investors also reacted positively to news that the benchmark Shanghai Composite index is to be rebalanced with a greater bias towards technology stocks.

Reporting season started in earnest for S&P500 companies. The bar was set low with aggregate earnings expected to decline by 44%. Yet, with 60% of companies having already reported, earnings have exceeded forecasts by 23% and Q2 is on track to record the largest earnings surprise since FactSet records began in 2008 [vi]. Technology and consumer discretionary stocks dominated the positive reports as the main beneficiaries of the surge in online consumption and service provision. In addition, a study by Credit Suisse conducted during earnings season concluded that some of the largest US multinationals have continued to buy back shares despite expectations to the contrary following the pandemic, thereby adding a further support to the US market.

Once again, the UK was one of the worst performing markets, dragged down by the Banking, Oil & Gas and Telecom sectors which suffered from disappointing company earnings. Of note, Royal Dutch Shell reported an 82% decline in net income while Lloyds Bank, considered to be a UK bellwether, adopted a more pessimistic stance on the UK economy than when it reported three months ago.

 

[i] bbc.co.uk – TikTok: What is the app and how much data does it collect?; August 3, 2020

[ii] The Economist – The EU’s leaders have agreed on a €750bn covid-19 recovery package; July 21, 2020

[iii] ft.com  – Fed warns resurgence of virus threatens economic recovery; July 29, 2020

[iv] Barclays Bank  – Morning Briefing; July 20, 2020

[v] ft.com  – US junk bonds notch up best month since 2011; August 1, 2020

[vi] FactSet  – S&P500 Earning Season Update; July 31, 2020

 

 

 

 

 

 

 

 

 

 

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