By Kevin Miskin, Hottinger & Co
We concluded last month’s investment review with the opinion that whilst October had ended in a sombre mood, as the second wave of Covid-19 gathered pace, November could be a pivotal month with the US going to the polls and there being some hope that news regarding a vaccine could be on the horizon. A few short weeks later and the MSCI World Equity Index has reached a record high, having gained 12.7% in November, as a well-received US election outcome and three surprisingly positive vaccine test results removed two key sources of uncertainty for investors.
In the weeks before the election, investors had adopted a positive view of the prospect of a Democratic “blue wave” delivering the key to unlock additional fiscal stimulus. However, as is became apparent that the Republicans would likely retain control of the Senate, barring the Democrats winning in Georgia on January 5th, investors changed tack to focus on the benefits at a company level, with President-elect Biden’s ability to pursue interventionalist policies restrained. Investors also remained sanguine about the outgoing Administration’s post-election disruptive policy decisions, including the Treasury’s termination of some of the emergency lending facilities that were put in place as a response to the pandemic and Donald Trump’s executive order prohibiting US investors from holding shares in companies with suspected ties to the Chinese military.
Whilst the election result would have dominated the news in most months, it was the announcement of surprisingly effective vaccines from Pfizer / BioNTech, Moderna and Oxford / AstraZeneca that proved the real game changer for markets. Equity markets soared and the ten-year US Treasury rose to nearly 1%; levels not seen since last March. Sectors that stand to benefit most from the reopening of economies, including autos and construction materials posted double-digit gains, but it was the banks and energy companies that lead the way. By contrast, this year’s beneficiaries of the pandemic including technology, healthcare and staples lagged. Barclays attributed the flight to value stocks as mainly short covering rather than an outright shift away from growth stocks by long-only investors, the vast majority of whom missed the sudden rotation. Nevertheless, the recent movement should be welcomed as it has improved the breadth of the market [i].
The swift rotation also brought an unfamiliar look to the monthly geographic performance tables with the growth-biased Chinese (CMI 300 +5.6%) and US (S&P500 +10.8%) equity indices lagging those in the UK (FTSE100 +12.4%) and Europe (Euro Stoxx 50 +18.1%), where value is more prevalent. Yet, to put the last month’s moves into perspective, the S&P500 has gained 12.1% this year and broke through the 3,600 level in November to record a new all-time high, while over the same period the Euro Stoxx 50 is down by 6.0% and the FTSE100 is struggling to break through 6,500, having started the year above 7,500.
Gold was out of favour amid the more positive environment and declined by 5.4% during November, representing its worst monthly performance in four years. The progress in the search for a vaccine has reduced uncertainty and could result in higher real yields, both negative developments for gold. We continue to hold the yellow metal in portfolios for diversification and to hedge tail risks [ii].
While there may be light at the end of the tunnel, the journey may not be smooth with a potentially tough winter ahead before widespread vaccinations can be rolled-out. Renewed lockdown measures in Europe are having the desired effect in suppressing the virus, but at a cost. Mobility data has slowed and the European Commission has lowered its previous recovery projection for 2021 by 2 percentage points to just 4.1%.
In the UK, chancellor of the exchequer Rishi Sunak announced the economy would shrink by 11.3% this year, the largest contraction in 300 years, and warned that fiscal consolidation may eventually be necessary. Meanwhile, the Office of Tax Simplification, which advises the government on improving the tax system, has recommended the rate that investors pay on realised gains (currently 20% for the highest earners) should be more closely aligned with income tax, where the highest rate is 45% [iii]. Any such moves could lead to interesting discussions within the Tory party where some of its MPs are already mobilising to warn the chancellor against touching taxes on profits, capital gains or pensions [iv].
In the US, even before the vaccine news came to light, the speed of the recovery had exceeded forecasts. In April, the IMF predicted that the economy would contract by 6% this year, but recently scaled back the severity of the decline to 4%. Meanwhile, unemployment peaked at 14.7% in April before declining to 9% in June, where the Federal Reserve had expected it to remain until year-end; it has continued to decline and currently stands below 7%. America is not expected to suffer a double-dip recession, unlike Europe, and will probably not impose lockdowns as severe as those across the Atlantic [v]. Nevertheless, tighter restrictions are being implemented in individual states as cases continue to rise, while the infection rate in the days following Thanksgiving will be closely monitored.
On balance, it is likely that Q4 growth will slow in the developed world as a result of the most recent lockdowns and restrictions, and this loss of momentum could carry into the early part of next year before vaccinations are rolled out. Therefore, looking at a six-month time horizon, we would continue buy equities in the event of any pullback in the short-term. A major question is whether the recent rally in value stocks has legs.
The key could lie in the government bond market. Ten-year yields spiked higher immediately following the initial vaccine news from Pfizer before ending the month broadly unchanged. A rise in long-dated government bond yields as a result of stronger economic fundamentals weakens the case for paying a premium for growth companies, while a steeper yield curve would unlock banks’ revenues through a revival in net interest margins. For the recovery in Value to be sustainable, yields would need to move higher. This scenario is not inconceivable with the US 10-year Treasury yielding sub-1% at a time when the US economy forecast is to grow by 7.5% next year, according to Morgan Stanley [vi]. Of course, any recovery will have to be backed-up by earnings but with revenues having been decimated in many value companies this year, the bar should be set relatively low in 2021.
[i] Barclays – Equity Market Review – Hope vs. reality; November 20, 2020
[ii] Absolute Strategy Research – Gold losing its shine; November 27, 2020
[iii] FT.com – What does CGT review mean for investors? November 13, 2020
[iv] The Economist – The Spending Review reveals the strains on the Tory party; November 28, 2020
[v] The Economist – What a vaccine means for the America’s economy; November 14, 2020
[vi] Morgan Stanley – Sunday Start; November 22, 2020
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