The World In A Week - The Doors Are Opening
It has been 84 days since lockdown in the UK was announced in which we have seen a period of great change and an immediate shift to our lifestyles. We have seen just over a quarter of the UK‘s working population supported by the Government’s furlough scheme with its estimated cost currently sitting at £19.6bn. As non-essential businesses begin to re-open their doors today, we appear to be getting closer to a state of normality. Boris Johnson has suggested that the two-metre social distancing rule could be relaxed as the hospitality sector prepares to reopen from 4th July.
In the last week, market volatility has been very high as the markets have tried to price in a quick return to normality. However, UK GDP fell by a record 20.4% in April as lockdown has paralysed the economy and halted businesses from functioning. The markets were quick to react to this data release as the FTSE All-Share fell 3.82% on Thursday, its biggest daily drop since the market sell-off, back in March. In simple economic terms, consumption has been the biggest component of GDP to be affected, with primary spending restricted to the groceries & e-commerce sectors.
Equity markets are typically driven by company fundamentals, forward cash flow estimates and forecasted earnings. In the current market, there is low visibility in these metrics, and so valuations are currently distorted. Previous recessions have followed a V-shaped recovery however, the markets continue to disseminate new economic data and the expectation is that we are likely to see more of a W-shaped recovery. Volatility is expected to continue in the interim as the market is displaying bunny-market characteristics as share prices hop up and down.
Any opinions stated are honestly held but are not guaranteed and should not be relied upon.
The information contained in this document is not to be regarded as an offer to buy or sell, or the solicitation of any offer to buy or sell, any investments or products.
The content of this document is for information only. It is advisable that you discuss your personal financial circumstances with a financial adviser before undertaking any investments.
All the data contained in the communication is believed to be reliable but may be inaccurate or incomplete. Unless otherwise specified all information is produced as of 15th June 2020.
The World In A Week - Interim Update
Two important publications have been produced since our update on Monday. Firstly, we had the OECD’s (Organisation for Economic Co-operation and Development) Economic Outlook, which was predictably gloomy.
As part of our macroeconomic monitoring, we track the OECD’s Composite Leading Indicators on a monthly basis which gives us a broad-based indication of where each economy sits in the business cycle. As expected, we have seen a sharp slowdown in economic activity with the data for the UK looking particularly poor. The recent surprise unemployment numbers in the US has shown however, that it is currently extraordinarily difficult to measure or forecast the impact of the Coronavirus shutdown.
Secondly, we had the latest meeting of the Federal Open Market Committee, the group within the Federal Reserve who decide on US monetary policy. As we fully expected there were no surprises, however, Jerome Powell has erased all doubt around the short-term future of US interest rates. In the projections that accompany their statement, the consensus amongst the committee members is for rates to remain between zero and ¼ percent until the end of 2022.
So, the markets are faced with a dire warning of an historic 6% decline in world GDP, which is not a surprise to anyone, and conversely being told that central banks will be in accommodative mode for the foreseeable future.
Markets are reacting to the ambiguous outlook, reflecting the current macroeconomic uncertainty and unclear guidance on the next phase of combating the virus. Our own investment positioning, of being globally diversified and neutral on equities, reflects the risk of this rise in volatility.
The World In A Week - The Sky's The Limit
Risk assets enjoyed another strong week at Friday’s close, led by US equities. It is almost incomprehensible to think that the S&P 500 and the US dollar are almost back to the same levels seen at the beginning of 2020. Positive data helped spur the rally; US non-farm payrolls surprised to the upside, climbing 2.5 million in May, a very different outcome to the 7.5 million loss that analysts had forecast, and unemployment also fell to 13.3%, defying expectations of a rise to 19%.
The ECB continue to do ‘whatever it takes’ to support the Eurozone; following the announcement that Germany had agreed a stimulus package of €130 billion. Christine Lagarde, Chairwoman of the ECB, announced that they would raise the Pandemic Emergency Purchase Programme, PEPP for short, by a further €600 billion, taking the programme to €1.35 trillion in total. The programme has also been extended and will run out in June 2021 at the earliest.
In the UK, there has been a step change in the Government’s view on the hospitality industry, specifically pubs, restaurants and hotels. Previously, the sector was due to open in July at the earliest, but a new plan outlined by the Government, means that pub gardens could be open as soon as 22nd June. The ‘Save Summer Six’, led by Chancellor, Rishi Sunak, has a clear mission to get the economy up and running after being warned by the Business Secretary, Alok Sharma, that 3.5 million jobs are at risk.
The World In A Week - Interim Update
They just keep on coming. The latest in stimulus packages, at a modest €130 billion, comes courtesy of Germany. This is for Germany rather than the Eurozone and was much larger than expected, with the emphasis firmly on increasing demand. It will include a cut to their VAT, several infrastructure projects and €300 for every child. This should make the meeting of the European Central Bank today a happier place and will help underscore the need for both fiscal and monetary support to continue unabated during this time.
While the headlines about COVID-19 start to diminish, the void is quickly replaced with political upheaval. The reigniting of the US vs China battleground has taken to the skies, with the proposed suspension of passenger flights arriving from China. China currently operates flights to the US but only with four domestic airlines. The friction comes from their continued ban of allowing US airlines to operate the route and the latest move adds pressure to release that ban, keeping the political leverage of tensions between the two countries firmly in place.
Another airline that is feeling the pressure of the lockdown is EasyJet, having been demoted to the FTSE 250 during the quarterly shake-up of the UK equity indices. Yesterday’s reshuffle saw airlines and travel companies among the sectors being relegated from the FTSE 100. Promotions to the FTSE 100 were companies with a digital focus, such as gaming company GVC Holdings, cyber-security firm Avast and home improvements business HomeServe. The FTSE 250 also had a similar focus for its promotions, with gaming firm 888 Holdings and online electrical retailer AO.com.
Is this an indication of what we have all been up to during the lockdown? Stockpiling frozen goods, DIY and playing online bingo.
The World In A Week - Lockdown Wind-down
The last week saw a broad risk-on sentiment emerge, with global Equities as measured by MSCI ACWI return +2.1% in GBP Terms. This was driven by Japanese and European Equities, while US Equities lagged driven partially by a weakening Dollar vs the Pound Sterling. Interestingly, “Value” equities strongly outperformed “Growth” equities by almost +2.0%. The Value segment of the market, which includes firms operating in the energy, financials and materials sectors, had been unloved by the market for some time – but has now potentially reached a point whereby they are so cheap relative to their Growth counterparts that there is room for significant upside.
It looks like the market is positioning for a scenario whereby economic growth picks up strongly following the pandemic lockdown, with an associated increase in inflation and a weakening of the ‘Almighty Dollar’ from historical highs. There is a reasonable basis for this positioning. Last week saw the continued advancement of a proposed €750bn recovery fund for the Eurozone, funded by mutually issued debt for the first time. This financial burden sharing would be one step towards resolving the structural flaws in the single currency.
Significant downside risks remain however, the principal one being that the economic recovery falls short of what the market is expecting or there is a significant second spike in coronavirus cases. To add to this, we face increased tension between China and the West over the latter’s designs on Hong Kong, as well as an upcoming US election amid rioting across American cities.
The World In A Week - Interim Update
News flow is beginning to contain something other than easing of lockdowns and vaccines.
Economies around the world are beginning to re-open, ahead of the schedules that were first announced back in the middle of March, and infection rates look to have largely been contained. The worst-case scenarios that made the headlines three months ago, now have a much lower probability of actually occurring.
Let us not forgot that any signs of market weakness have been met with additional support from central banks and governments. Japan’s announcement yesterday of an additional $1.1 trillion fiscal stimulus package continues that theory.
Whilst all of this is generally good news, the world’s media needs to find the next dramatic headline and as we wrote on Tuesday, the souring relations between the US and China are taking a more serious step. Last night, US Secretary of State, Pompeo, stated that the US could not consider Hong Kong as being autonomous from China, which does have significant consequences, as it may affect Hong Kong's special trading status with the US.
The political leverage that Donald Trump seeks to gain from managing the US/China relationship is becoming a key element in his re-election campaign. As we wrote last year, when the Phase 1 deal was penned, this New Cold War is not something that will dissipate anytime soon.
Finally, Brexit has once again hit the headlines. The EU have told Westminster that Brussels remains open to extending the transition period by up to two years. Talks on what the trade deal will look like remain unresolved, with the original target date of 30th June 2020 looking less likely to be met.
The World In A Week - Crunch Time
Tensions are running high. The balance between keeping economies locked down in order to protect the health services, and the desire to loosen lockdown measures in order to lessen the long-term impacts, is coming to a head.
Here in the UK, there has been tentative rhetoric that we are preparing to lift restrictions, but attention has shifted towards accusations that Boris Johnson’s senior aide broke lockdown rules. All nations will need unity to help with smoothing the economics of a bounce back, and Dominic Cummings’ actions will certainly be an unwelcome spanner in the planning.
In the US, we have already commented on the increasing pressures between itself and China, mainly at the finger of Trump’s Twitter account. Over the weekend, it was the turn of China’s foreign minister to ratchet up the tension, accusing the US of pushing relations to a New Cold War. All of this could mean short-term volatility in financial markets.
However, support for markets from both central banks and governments remains significant. Last week, France and Germany proposed a €500 billion Recovery Fund that would represent a significant step towards fiscal mutualisation in the Eurozone. What does this mean? The idea is that the distribution of the Fund’s resources will be based on need, while the burden of the repayment will be based on ability. This will treat the Eurozone as a whole, with the arguably stronger nations, such as France and Germany taking on greater burden, while less well-off nations, such as Italy and Spain, can benefit from the resources of the Fund.
We knew the route to combat COVID-19 would be uncertain and we appear to be at another inflection point. While the short term remains unclear for markets, the monetary and fiscal support appears to be the one constant.
The World In A Week - Interim Update
It is happening again. President Donald Trump has been busy with his Twitter account this week and the focus of his attention is China. Trump’s increasingly critical comments of China could be a worry for the longer-term economic bounce back.
Whilst pent-up demand during lockdown is potentially a boost for US growth in the short term, restoring the level of growth to where it was before COVID-19 will require a stronger underlying economy, and reawakening trade tensions with China will not help.
There is more at play here than meets the eye though; casting China as the villain has been successful in the past for Trump’s approval ratings, and in a recent survey amongst Republican voters, disapproval of China is at 72%. With the US Presidential Election not far off, seeds are already being planted for campaign strategies. For the Trump team, it will be a difficult balancing act of building political support and ultimately keeping the trade deal alive.
In the UK we saw the official rate of inflation drop significantly from 1.5% in March to 0.8% for April, and below economists’ expectations of 0.9%. Driven downwards by falling commodity prices, as well as reduced spending and increased savings, a result of having so many people in lockdown. This has prompted the Bank of England to make a U-turn on the possibility of negative interest rates in the UK.
The Governor of the Bank of England, Andrew Bailey, confirmed that policy had changed slightly and that they were reviewing all tools possible to help alleviate the impact of the coronavirus. He did stress that the Bank needed time to consider the implications of such a move and they want to see how the economy reacts to the previous rate cut to 0.1% before enacting further monetary policy.
The World In A Week - Schools Out
A recent rally in equity markets has seen the S&P 500 only down by -2.6% in 2020 in Sterling terms. However, the FTSE All-Share remains the poorest performing equity asset class; down -23.0% for the year. The S&P 500’s recent upsurge partially attributes to the depreciation of Sterling which continued to drop last week amid stalling Brexit negotiations between the UK and the EU.
Rishi Sunak has extended the Government furlough scheme to the end of October as he aims to curb the number of job losses caused from the virus. Already 7.5 million workers are on the furlough scheme, which equates to 23% of the total working population. The Government initiative is estimated to cost £14 billion per month and could reach £80 billion.
The reopening of schools appears to be the biggest debate as Michael Gove discussed his intentions to reopen schools providing conditions were met that include smaller classes and staggered arrivals. Denmark was one of the first countries to reopen schools back in April, prioritising its younger children to return to class, whereas Germany has given precedence to their older students. Much of Europe have reopened their schools and have taken precautionary measures to ensure a safe environment including regular breaks to use hand-washing facilities. Globally, almost 1.6 billion students have been affected by the pandemic and further guidelines are expected to be revealed later this week.
The renewable energy sector has flourished in recent months from lower electricity demand and brighter weather conditions with solar farms powering almost 30% of the grid. The UK has now reached 34 days without operating with coal as of the 14th May. Global energy demand has declined 3.8% in Q1 of 2020 with coal demand falling by 8% and oil demand by 5%. Besides a greener environment, the pandemic has highlighted the importance of international co-ordination and co-operation, as we have seen social distancing operated on a global scale. If a similar stance is taken going forwards, the hope is that the fight against coronavirus will transpire into a successful global response to climate change.
The World In A Week - Interim Update
It appears to be more of the same for this mid-week update. The predictable cycle of forward guidance regarding more economic stimuli, in order to combat the fear of unemployment numbers, and the containment of COVID-19. The desired outcome being sufficient reassurance to consumers to help ignite the economic bounce back.
US sales data published earlier in the week was an early indication of the resilience of consumers, showing a positive surprise from the forced savings that have been accrued during lockdown. American consumers pushed May’s retail sales report to a record 17.7%, smashing through the expected rebound of 8.4%. This has seen over 60% of the loss accumulated through January to April recouped in May.
However, we must remember that the bounce was from a depressed seven-year low and the retail sales trend at an annual rate is still significantly in the red. Context is everything, especially during more volatile periods.
Monitoring the reaction of markets to the rising number of virus cases is critical, as straight-line extrapolation creates opportunities, especially when central banks and governments are willing to underwrite extreme volatility.
Any opinions stated are honestly held but are not guaranteed and should not be relied upon.
The information contained in this document is not to be regarded as an offer to buy or sell, or the solicitation of any offer to buy or sell, any investments or products.
The content of this document is for information only. It is advisable that you discuss your personal financial circumstances with a financial adviser before undertaking any investments.
All the data contained in the communication is believed to be reliable but may be inaccurate or incomplete. Unless otherwise specified all information is produced as of 18th June 2020.