The World In A Week - Phoney War
Last week saw a moderate rise in the value of risk assets with the FTSE All Share up +0.65% and the MSCI All Country World Index down -0.36% in GBP terms, as the value of Sterling rose against the Dollar and many other major currencies. Within Equities, the Emerging Markets and Europe lead the way, while Japanese Equities lagged.
This sentiment was also broadly reflected in Fixed Income markets, Investment Grade Credit, High Yield Bonds and Emerging Market Debt all advanced – while Treasury returns were more subdued.
The relative tranquillity observed in markets was at odds with the slew of dreadful economic news that hit the headlines last week. It was announced that the US economy lost 20.5m jobs in April, rocketing the unemployment rate to 14.7% - a new post-war high. Consensus is now gathering that the likelihood of a “V shaped” recovery from the coronavirus is getting closer to zero. The unprecedented increases in unemployment are likely to take a long time to unwind, and consumer’s purchasing power and habits may well be changed for good.
However, since their nadir on the 23rd March 2020, Equity markets have paid little heed to the deteriorating economic fundamentals, with MSCI ACWI up +18.2% and the S&P 500 up +21% in GBP terms. In the riskier Fixed Income markets, we have also seen a strong rally in High Yield Bonds from their lows, although this is arguably not as over-extended as the Equity markets. As we celebrated Victory in Europe Day over the Bank Holiday weekend, it has begun to feel like a phoney war mentality has taken over the markets – one that may collide with reality in due course. While the rally demonstrates the necessity of maintaining market exposure through all stages of a cycle, we remain neutral on Equities at this point.
The World In A Week – Interim Update
A week that has been punctuated by uncertainty and conjecture. As we get to the end of the second three-week lockdown period in the UK, headlines are full of rumour. No one knows what the effect of easing the restrictions will be, and as we have written previously, fear is one of the biggest dangers to the economy.
The economics of ending a lockdown seem to depend on fear and confidence. Consumers need to have assurance around the security of their jobs and feel safe about their risks to their health. If that scenario occurs, then there is the likelihood of consumers spending that short-term pent-up demand.
The balancing act is all about the timing. Too soon and the conditions mentioned above will fail and the potential short-term economic bounce will be snuffed out. That is the tightrope politicians are walking; managing the populations’ expectations, with as light touch as possible around social control, while knowing the longer the delay, means the longer the overall economic recovery.
Meanwhile, the Bank of England has left policy unchanged at their meeting yesterday. Whilst the committee voted unanimously to maintain interest rates at 0.1%, there was also a majority vote of 7-2 to continue with the programme of purchasing £200 billion of UK government bonds and non-financial investment grade corporate bonds. The two members who dissented were actually looking to increase the purchases by an additional £100 billion. A reminder that central bank policy around the world is still firmly in supportive mode.
The World In A Week - The End Of The Beginning
Boris Johnson returned to no. 10 in full capacity last week after successfully defeating the coronavirus. Boris returns to a torn party, split by those in favour of easing lockdown restrictions and those that believe lockdown restrictions should remain in place for longer. Clarity was provided as the week progressed with indications that lockdown measures will be eased, although to what extent, is currently unknown. Boris has promised to outline a ‘comprehensive’ plan of how we will move out of lockdown on Thursday; media speculation is already underway with the primary focus on allowing individuals to choose up to 10 people to include in their social circle.
In a further blow to income investors, UK dividend cuts continued to gather pace. FTSE 100 constituent, Shell, stunned investors by cutting its quarterly dividend by 66% following the collapse in global oil demand and the virus pandemic. The UK dividend market is a key component in global equity income portfolios and given the pace of dividend cuts across the UK market, will put global equity income managers under pressure, with many expected to miss their yield objectives. Income has been a key area of focus for the Investment team and we are finding other areas of opportunity. Asia, an area not typically associated with income, has proved an interesting hunting ground, the region has a lower payout ratio but fewer dividend cuts are expected. Infrastructure is also another area of interest; the sector typically yields between 4-5% and is expected to provide an element of protection in a downturn.
In Europe, the ECB made no changes to interest rates last Thursday but emphasised they remain poised to increase stimulus if needed. The eurozone is expected to be one of the areas hardest hit and will likely suffer a deep recession. While the ECB has confirmed it will do ‘whatever it takes’ to support the euro area, should the current daily pace at which the ECB is buying government bonds continue, the program will reach its limit in October. Last month, the ECB reduced costs for commercial banks to support lending activity and last week, said it would reduce these interest rates further to -1% - effectively paying them to borrow money. Data in the region published on the same day, revealed that the economy had contracted by 3.8% in the first quarter, an all-time low since records began in 1995.
The World In A Week – Interim Update
US GDP fell 1.2% quarter-on-quarter; however, you may have seen the media run with headlines that stated growth falling by 4.8%. It seems pointless to annualise the data at this point, as one thing is almost certain; the next quarter will be a very different number.
There was no movement from the Federal Reserve, who held their Federal Open Market Committee meeting yesterday. They have already committed to do whatever it takes and the drop in GDP was fully expected, which was reiterated in Jerome Powell’s rhetoric.
Expectations are increasing on what the easing of the lockdown measures will look like in reality. Several European countries have already given broad indications of when the easing will begin. Preparations are apparently underway for the UK Government to issue detailed guidance on how Britain can safely go back to work.
Boris Johnson, after celebrating the birth of his son yesterday, is today expected to announce that the coronavirus is being contained, but that it is not yet time to lift the restrictions. Concern is about lifting the lockdown measures too early and run the real risk of a second spike of infections. Silver linings and management of expectations for the public is key at this moment.
The World In A Week - Balancing Act
The focus last week was mainly on the US, which is arguably seen as the new epicentre for the pandemic and, perhaps, the road map for the next phase in this battle.
US equities recorded their first weekly drop in April, illustrating a volatile week that saw indices buffeted by record unemployment claims, disappointing drug trials and an oil price that went negative. The week did end strongly though, as sentiment was lifted by the authorising of the fourth US economic relief package since the pandemic began.
President Trump signed off the $484 billion stimulus package into law, which aims to provide additional relief to small businesses, as well as hospitals, with the aim of increasing coronavirus testing. Never one to miss an opportunity to tweet, Trump also promoted the theory of pent-up demand on his Twitter feed; people in lockdown are generally spending less, meaning enforced savings, and it is those savings that could support a bounce back when the lockdown is lifted, as long as fear is contained.
Trump has also signalled support for ‘reopening’ in his Twitter feed, coinciding with the US state of Georgia, which has rolled back some of the lockdown measures, allowing small businesses such as hairdressers, spas and tattoo parlours to reopen. It also emphasises the dilemma of how social distancing will work at this interim stage, as all of the above businesses involve close contact.
The dichotomy of wanting to supply a service, to keep your business solvent, but at the same time wanting to keep your family safe through social distancing, is another challenge for people and governments to find a solution and tackle the fear of risk. If reopening is enacted too early, or people believe it is too early, fear of the virus could do more economic damage.
The next stage is a difficult balancing act of keeping the population safe, whilst managing people’s expectations for when the lockdown measures could be relaxed. Governments will want to restart their economies as soon as possible but acting too early could be worse than acting too late.
The World In A Week – Interim Update
There is always an anomaly that appears during a crisis to disrupt markets or economies to an extreme, and the COVID-19 crisis is no exception. Rising production and collapsing demand, due to a deliberate policy of an economic shutdown, is causing an unprecedented glut in the oil market. This has sent oil prices for West Texas Intermediate (WTI) to a multi-year low, which reached negative at one point.
Travel restrictions, due to social distancing stay-at-home sanctions, have reduced the global demand for oil by an estimated 5.6 million barrels per day (mb/d). Research conducted by BP shows that almost 58% of global oil demand is derived from fuel for transportation. This makes the current situation much worse than a normal recession because of the widespread implementation of travel restrictions.
This problem has been brewing for a while, with Russia and Saudi Arabia unable to agree on production cuts in early March. This caused a bizarre situation in which Saudi Arabia actually increased production and sparked a price war. The main oil producers gathered around the table at Easter and agreed to an historic cut in production to contain the oil glut. Production will be cut by 9.7 mb/d starting on 1st May. Cuts will begin to taper each month to 5.6 mb/d by the end of the year.
Despite the historic significance of the agreement, the agreed cuts do not appear to be aggressive enough to balance the large drop in demand. Oil inventories are likely to continue to rise in the short term, with storage facilities at capacity; this is putting further pressure on oil prices.
The anomaly of negative oil prices happened this week, with the May contract for oil delivery, for WTI, falling as low as -$40 a barrel. The situation was created by holders of the oil contracts having to pay to have the oil taken away and stored. Global storage of oil is almost at capacity, which increases the prices to have the commodity stored. This price of storage exceeded the actual price of the oil itself, thereby creating a negative contract.
This volatility in oil prices has spilled over into other asset classes, with global equities feeling the pressure. It is likely that the distortions we are seeing in the oil market will contribute to volatility in other asset classes, in the short term. However, it is expected that this period of extreme dislocation will dissipate in the second half of the year, as travel restrictions are gradually relaxed. So, while oil could contribute to volatility in equities and fixed income over the coming months, we do not expect it to become a major driver.
The World In A Week - Start Of Something New?
It has been 28 days since Boris Johnson delivered his address announcing that the UK will be placed in a state of lockdown. On Thursday, the Foreign Secretary, Dominic Raab, declared that the lockdown would be extended for at least another 3 weeks. It seems like we have settled into our social distancing routine. We have adapted to our working life and we have discovered new hobbies to replace our commutes.
Our new lifestyle has encouraged greater reading, home-exercise and cooking which could spark a new healthier way of life. We have already experimented with the idea of operating remotely from home and this could result in a more permanent shift. With the much-improved workplace software now available, employers are weighing up their need for office space and we could be approaching the start of a drastic change in the workplace environment.
The UK’s first quarter GDP data is set to be released at the end of April; however, Q2 GDP data is expected to capture the largest proportion of the economic downturn. Markets were largely flat last week except for the S&P 500 which was up 2.76% in Sterling terms. Most notably MSCI China was up 2.28% last week in Sterling terms and its year-to-date return reached 0%.
Last week also marked the start of increased M&A activity with the Competition and Markets Authority provisionally approving Amazon’s investment in Deliveroo who had stated that, without an injection of funds, they would face exit from the market. Deliveroo has been hit hard by the closure of restaurants and hence, would not survive the pandemic. Despite concerns that the investment would reduce the potential for new competition, it was decided that business continuity and availability of food override competition concerns. Predatory buying behaviour from larger companies is expected to continue as they operate larger cash reserves and greater market power.
This period of change may also encourage new market entrants as seen with Zoom’s rapid expansion in the video communications sector. Zoom was trading at $76 in mid-January and is now trading at $150 as of mid-April following their speedy uptake. Unemployment has understandably spiked since the lockdown measures were introduced with 1.4M unemployment claims being made. Employers should aim to seek alternatives such as furloughing staff or reducing working hours rather than resort to redundancies, to mitigate the negative effect on the economy.
The World In A Week - Interim Update
We previously wrote, just two weeks ago, about the risk of economic forecasts during this period of uncertainty. The unreliability of data during the lockdowns will, in turn, make the forecasts equally unreliable. Although there is some consensus around how long economies will take to get back to pre-crisis levels, the range of forecasts for how much damage will be done is historically wide.
The one forecast that did hit the headlines was from the Office of Budget Responsibility (OBR), who caveated their forecast by stressing it was not a forecast at all. Their ‘illustration’ of the potential fiscal effects of a three-month lockdown gave us a 35% reduction in output and unemployment of two million. The silver lining beyond the headlines that the media ran with was OBR’s assumption of “no lasting economic damage” beyond a short downturn.
Naturally, focus is starting to centre around what an exit-strategy from lockdown will look like, however, not all economies will have the same experience of dealing with different phases of the virus. Reinvigorating a weak economy from a lockdown will depend on having sufficient stimulus in place and a consumer base willing to consume. That means keeping unemployment as low as possible.
The Federal Reserve announced this week that it will expand the size and scope of its lending facilities to provide up to $2.3 trillion in loans, in support of the US economy. This is to provide business with much needed liquidity to ensure that as many jobs as possible remain open when the furloughing ends.
We must also remember that this slowdown is not due to structural imbalances around the globe; but a deliberate policy-induced slowdown, which may not echo previous slowdowns. It is about keeping an open mind to the range of possible outcomes and not jumping to conclusions too early.
The World In A Week - A Rally From Awful To Bad
The last week before the Easter break saw risk assets rally strongly as investors left the haven of cash and re-entered the market. While High Quality Bonds rallied +0.3%, the greatest moves were seen in the riskier segments of the Fixed Income markets, as High Yield Bonds gained +4.7% and Local Emerging Market Debt rallied +4.6%. In Equities, Global Equities as measured by MSCI ACWI rose +8.6% in GBP terms, while the S&P 500 Index of US Equities rallied +10.3% - its strongest weekly performance since 1974.
While we expect markets to remain volatile to the upside and downside for the remainder of the year, the returns highlighted above illustrate the critical importance of remaining invested throughput the market cycle – no matter how painful the prior drawdown may have been.
Market performance has been driven by a number of factors, which of course all centre around the ongoing Coronavirus pandemic. Chinese trade and economic data has been better than expected as the Middle Kingdom begins to lift restrictions, awakening dormant companies. As with all Chinese data, this should be treated with caution, however. It has been reported that over 70 vaccines are being developed globally, with some about to begin human testing. In addition, some European countries are beginning to contemplate re-opening their economies – although the situation remains bad in the UK.
The economic damage caused by the virus will likely have ramifications for some time, and pockets of infection or re-infection may arise around the globe sporadically. This informs our view that market volatility will persist.
The World In A Week – Interim Update
We knew it was coming, but that did not stop the market from overreacting to what is undeniably a certainty.
The UK economy shrank at the fastest monthly rate on record during March, due to the lockdown and the enforced economic slowdown. UK gross domestic product (GDP) fell 5.8% compared with the previous month, making it the largest drop since records of monthly GDP began in 1997.
It also meant that the UK has had its first quarter-on-quarter drop in GDP since the Global Financial Crisis. The 2% fall compares to falls of 1.2% for the US and 3.8% for the Eurozone. The recession will technically become official when we have a negative reading for this quarter, as you need two consecutive negative quarters for a recession.
Although much of this was widely expected, it did not stop the market reacting wildly. The first three days of this week saw the FTSE 100 swing more than 200 points, evidencing that volatility is here to stay. As we wrote on Monday, the likelihood of a ‘V’ shaped recovery has dissipated, and our base case of a ‘W’ shaped market is looking more probable.
That means more commitments of economic stimulus if markets became too unruly. In anticipation of this, we have already had proposals from the US of an additional $3 trillion fiscal package. However, there is a conflict building between those who see these extreme measures as absolutely necessary, and those that fear the spectre of rising debt will come back to haunt us. Exceptional times call for exceptional measures and ultimately the combined total of the global promises is essential to combat the global pandemic.