Please see this week’s Brewin Dolphin – Markets in a Minute Update:
As you can see from the above, the volatility continues and is likely to do so for a while yet.
Please keep checking back for a variety of updates and content sourced from some of the best investment houses in the industry, short regular updates like this aim to help you understand what is going on in the ever changing markets.
Andrew Lloyd
30/09/2020
Please see below for the latest blog from Legal and General’s Investment Management Team regarding their ‘key beliefs’ in relation to the markets:
This week, we look at the investment case for three strategies that should in theory be defensive: holding UK sovereign bonds, owning gold, and diversifying by equity factor.
As with all Key Beliefs emails, this email represents solely the investment views of LGIM’s Asset Allocation team.
A furlough bar to clear
We have been tactically underweight UK gilts for almost exactly six months now. This has been largely based on our view that: (1) a furlough extension was inevitable; (2) negative rates were not on the cards; and (3) the distribution of potential returns was likely to be negatively skewed given those first two factors.
Thursday saw Rishi Sunak extend the furlough scheme for another six months, but the new version is considerably less generous than its predecessor. Employees must now work a minimum of a third of normal hours and employers and workers must bear a greater share of the burden. This incentivises companies to retain one full-time employee rather than two employees working reduced hours, and we believe it will result in further redundancies and pressure on household incomes in the coming months.
Meanwhile, the debate on negative rates has ebbed and flowed at the Bank of England without much clear direction. The latest hints from Governor Andrew Bailey have seen the short end of the curve price out negative rates in the near term, but the Bank’s inconsistent communication on this issue makes it hard to have much confidence in the outlook.
Given these two developments, the third argument above has become harder to defend. While we maintain a negative view on gilts over the medium term, the changing balance of risks has led us to call time on our tactical position.
Going for gold
Given its perceived status as a safe-haven asset, gold is never far from our thoughts when assessing the multi-asset opportunity set. While we maintain a positive long-term bias on the metal, we need to stay price sensitive too. Having closed a tactical overweight back in July, at current levels we believe it’s time to scale back in again.
With interest rates close to zero in most developed markets and increasingly limited space for monetary policy against an uncertain backdrop, finding candidates to diversify the cyclical nature of equities and other risky assets has rarely been more challenging. Gold is, in our view, less exposed than many assets to innovative, unconventional future measures to ease policy, and we therefore believe it offers something different from fixed-income assets in that regard.
No investment is without risk, however. Gold price movements have historically closely tracked a combination of real yields and the US dollar, but there is the possibility that this relationship could be changing. In particular, with yields pinned close to zero it could be that inflation expectations and realised inflation become the more important future drivers of fair value. Given inflation expectations have tended to behave similarly to equities, that would seem at odds with gold’s expected role as a safe haven and diversifier.
Factor fiction?
A wide range of equity risk factors (or styles) have been identified in the academic literature, yet there remain relatively few that are both compensated (i.e. deliver a positive risk premium over time) and transparent (i.e. there is a plausible and widely accepted rationale for their persistence). Five factors have historically exhibited both characteristics: value, low volatility, quality, size, and momentum.
While individual factors can go through sustained periods of relative under- or outperformance, they are likely to do so at different times, so it follows that a balanced portfolio of factor exposures should provide a diversified and cost-effective way to gain exposure to the range of equity risk premia over time.
This year has nevertheless been tough on US equity factor portfolios, largely because of the outsized influence of technology stocks. The outperformance of the largest stocks in the market-cap weighted index has weighed heavily on the returns of any diversified equity strategies which move away from the ‘tallest trees’ in the index. Some of that underperformance has reversed recently as some of the froth in tech has been removed, but we believe it is too early to call a sustained rotation in the US.
The same cannot be said of factor portfolios outside the US, however, where there is much less of a tech bias. The recent bout of risk aversion has seen non-US factors behave more in line with expectations, with quality and low-volatility stocks outperforming, while value has been relatively flat. Where we have allocated to a basket of non-US equity factors, their positive contribution has been an effective diversifier over the past couple of weeks.
Detailed and focused opinions from market leading investment managers such as Legal and General can be a useful addition to your overall view of the markets.
Please keep reading our blogs to ensure your holistic view of the markets is well informed, diversified and up to date.
Keep safe and well.
Paul Green
29/09/2020
Please see below this week’s market commentary update article from Brooks Macdonald, which was received late yesterday afternoon:
Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.
Please keep safe and healthy.
Carl Mitchell – Dip PFS
IFA and Paraplanner
29/09/2020
I listened to a technical webinar at the end of last week presented by Prudential and their senior political and technical staff here in the UK. Following the cancellation of the Budget (was this previously a pre-Budget debate?) they were discussing what taxes might change when and the politics behind it.
Basically, it is a trade-off between what value any new tax might have (how much will it raise for the State?) balanced against the potential political damage any specific tax change may do.
Thankfully, on this basis a lot of the potential tax changes were discussed and dismissed as unlikely. I don’t think this is the end of the matter, we will need additional tax for the State to pay for the support during the pandemic and strengthen our recently exposed weak spots, the NHS, residential care, social services etc.
We will also need more money to kick start the economy and help us deal with Brexit, fudged deal, or no deal. As this is the case, when the economy is recovering, and the consumer is spending freely again (post vaccine?) we will see changes to the tax system.
Given the state of our economy and the outlook, the only thing we know with certainty is the tax position and legislation we have in place right now. If you have the means, why not take advantage of the tax reliefs and planning opportunities that are available today?
It makes good sense to press on with any beneficial planning now using what reliefs are available today, we know the rules now. For example, pension funding with higher rate tax relief within the pension contribution limits we have currently.
If you would like to discuss your own personal situation, please get in touch.
Steve Speed
29/09/2020
| Please see below weekly news update provided by Blackfinch earlier this afternoon, which provides a summary of current global events. |
| UK COMMENTARY |
| The UK Government lifted its COVID-19 alert system to its second-highest level following an announcement about a potentially tough autumn and winter period for the country New restrictions were imposed on business activity and movement of people, with PM Johnson confirming that they are ’likely to remain in force for six months’ The main restrictions are: office workers to work from home if they can; all pubs, bar and restaurants to operate a table service and close by 10pm; face coverings to be worn by retail staff, users of taxis and cabs, all staff and customers in indoor hospitality venues except when eating or drinking; COVID-secure guidelines to become legal obligations in all retail, leisure, tourism and ‘other’ sectors; no more than 15 people to attend weddings or wedding receptions; and that the ‘rule of six’ has been extended to all adult indoor team sports The restrictions have more to do with social distancing and health precautions, and the economic impact is unlikely to be as bad as initially thought The Rightmove House Price Index indicated house prices rose 0.2% in September from August and were up 5.0% on September 2019 The Flash UK Manufacturing Purchasing Manager’s Index (PMI) registered 54.3 in September, down from 55.2 in August The Flash UK Services PMI had the weakest performance in three months, coming in at 55.1 in September, down from 58.8 in August The latest data from the Office of National Statistics (ONS) suggests that around three million workers – around 12% of the workforce – were still on furlough or partial furlough in early September Rishi Sunak, Chancellor, acknowledged that he cannot save every job as he announced a new support scheme to enable companies to save viable jobs Under the scheme announced, people can work a third of their normal hours and to be paid the normal hourly rate for those hours, with the Government and the employers covering lost pay. All employers will be allowed to apply for the new arrangements from November, regardless of whether they used the furlough scheme The Government extended the 15% VAT cut for tourism and hospitality sectors to the end of March 2021 UK retail sales volumes grew at the fastest rate since April 2019 in the year to September, according to the Confederation of British Industry’s (CBI’s) Distributive Trades Survey The Bank of England governor has ruled out negative rates in near future National Savings & Investments announced a series of dramatic cuts to its rates and premium bond prizes. The premium bond prize fund interest rate is to be cut from 1.40% to 1.00% from December. Their income bonds will be cut from 1.16% AER to just 0.01% from 24 November. |
| US COMMENTARY |
| Technical changes to data methodology in Arizona and Texas for calculating confirmed cases and a rebound in testing activity helped explain a jump in cases at the start of the week The latest US weekly jobless claims data showed a slight increase for the week ended September 19th, which showed that 870,000 Americans filed for unemployment. This was 4,000 higher than the prior week and in contrast to market expectations of a fall to 850,000. Continuing jobless claims showed some more positive signs, falling to 12.58m from 12.75m but still above estimates of 12.28m Goldman Sachs halved its growth forecasts for US economic growth in Q4 to 3% from 6%. This is in recognition of the fact that Congress is unlikely to attach additional fiscal stimulus to the continuing resolution. Federal Reserve chairman Jerome Powell conveyed yet another downbeat assessment of the US economy to Congress. US lawmakers are yet to push out fiscal changes that central bankers see as needed. US housing sales hit a 14-year high as America’s housing market continues to shrug off the Covid-19 crisis, and high unemployment |
| EUROPE COMMENTARY |
| Indices struggled in Europe due to pandemic fears as there were a record number of cases reported in the Netherlands and France Eurozone business growth ground to a halt as services data stumbled. The Markit’s flash Eurozone Composite PMI was just 50.1, barely above stagnation, from 51.9 in August. This suggests the summer recovery is petering out. Markit’s flash German PMI report showed that service sector activity has hit a three-month low, while manufacturing is growing at the fastest pace in over two years. The jump in Covid-19 cases in France over recent weeks has dragged Markit’s preliminary French PMI down to 48.5 for September, from 51.6 in August |
| ASIA COMMENTARY |
| Shares in Australia were buoyant as the two-week average of new infections in the city of Melbourne fell below 30 The Kospi in South Korea fell 2.61% in afternoon trade after South Korea’s defence ministry said North Korea had killed a missing official from the South earlier this week |
| GLOBAL COMMENTARY |
| With fears riding high of tougher lockdown restrictions returning and the corresponding effect on the economy, the oil price fell heavily |
| COVID-19 COMMENTARY |
| US firm Novavax is set to start late-stage trials for its COVID-19 vaccine candidate in the UK. It will enrol up to 10,000 participants aged 18-84 over the next six weeks, with half receiving the formulation and half receiving a placebo. |
People & Business IFA Limited recognises the importance of communication in the ever-changing world we live in. Please continue to check in with us for the most up-to-date information and data.
Stay safe.
Chloe
28/09/2020
Please see the below article from AJ Bell, published late last week:
The sector is one of the worst performing over the last 12 months and past decade.
Fresh allegations from the International Consortium of Investigative Journalists (ICIJ) about money laundering at HSBC (HSBA) and Standard Chartered (STAN), among other leading global banks, may pertain to wrong-doing which is already covered by previously-paid regulatory fines, according to the lenders themselves.
But even if that is the case, the story gives investors another reason to wonder whether banks stocks are worth the bother, given their complex business models, the danger that loan books are harbouring a lot of debt that might be about to go sour if the economy turns down again and the threat posed by central banks’ monetary policy.
This is not how central banks see it. They argue that cutting interest rates and quantitative easing (QE) lower borrowing costs, creating demand for loans and credit that keep economies going.
But equity investors are clearly not convinced. Within the FTSE 350, banks are the third-worst performing sector over the last 12 months (ahead of only Oil Equipment & Services and Oil & Gas Producers) and the second-worst over ten years (beating just Oil Equipment).
This is a serious matter for holders of the Big Five FTSE 100 banks’ shares and those investors who get access to UK equities via passive, tracker funds – those same five banks represent 7% of the FTSE 100’s market capitalisation and, according to consensus analysts’ forecasts, are set to generate 12% of the index’s 2021 profits and 14% of its dividends.
Mangled margins
The problem, at least in the near term, is that low base rates drag down the interest rates that banks can charge on loans. Quantitative easing is designed to flatten out borrowing costs, too, so that credit spreads (the premium in interest rate paid by a company to a government) are also relatively narrow.
The net result is that the net interest margin on banks’ loan books is under fierce pressure, seriously undermining banks’ profitability and their ability to earn decent returns on equity.
An average decline in the net interest margin across the Big Five FTSE 100 banks of 52 basis points (0.52 percentage points) since Q1 2017 might not sound a lot. But that represents a 22% drop in the lending margin and on their current aggregate loan books of £2.2 trillion. That is the equivalent of £10 billion in interest a year – profit which could have been used to make fresh loans, perhaps, buffer balance sheets or even pay dividends to shareholders.
Some investors could be forgiven that the Bank of England’s monetary medicine is making banks feel worse, not better.
Global trend
In Europe, the European Central Bank has been tinkering with zero interest rates (and negative deposit rates) for some time, to no great effect so far as its 2% inflation target is concerned, but with deleterious consequences for banks’ profits and the returns on offer to their equity holders.
Unfortunately, investors in banks had already been warned of what might come their way. After all, the Bank of Japan has been fighting the effects of the bursting of a debt-fuelled stock market and property bubble since 1990, some 17 years before a similar fate befell the UK, Europe and America.
The effects of three decades of QE and ZIRP upon Japanese banking stocks are all too clear to see in the miserable share price peformance, and the Bank of Japan’s record in promoting consistent economic growth and 2% inflation, in line with its target, is spotty at best.
Only US banking stocks have shown any real signs of life in the past few years but the pandemic, a recession and reversal of Fed policy from tightening to easing appear to have taken care of that in 2020.
The disconnect between the market cap weighting and the estimated profit and dividend contribution means that either the FTSE 100 banks are too cheap or market doesn’t believe the analysts’ forecasts for 2021.
The experience of America’s investors suggest that banks’ profits and share prices need rising bond yields, as that may help lending margins, so that may be the catalyst that contrarian value seekers crave, although what it could do to their loan books when it comes to sour loans and impairment charges is another matter.
Economic growth and (some) inflation would be potential triggers for bond yields to rise. Central banks continue to strive for both and are now calling for further fiscal stimulus to help.
Until governments sanction more spending and higher deficits, banking stocks may continue to recoil from central bank policy statements which promise low interest rates for longer or even the dreaded prospect of negative interest rates, to the detriment of individual bank stocks and perhaps the wider FTSE 100 index.
Please continue to check back for our latest updates and blog posts.
Andrew Lloyd
28/09/2020
Please see the below update from a few of the fund managers at Jupiter posted late yesterday afternoon:
Would another market slump be the time to turn bullish?
It was only relatively recently that share prices of the high-profile US technology stocks, known as the ‘FAANGs’, were going parabolic. That’s not a good sign because it usually doesn’t end well, said Richard Buxton, Head of Strategy, UK Alpha. Indeed, the last couple of weeks have seen a notable pullback in those stocks. It’s the sort of move that makes the chartists get very excited and talk about prices returning to ‘key support levels’, he said.
Richard finds it very interesting that this setback has happened at a time when the Federal Reserve (Fed) has been very vocal in its commitment to prioritise employment over inflation targeting, and has said interest rates should be expected to stay on the floor until 2023 at least. And yet, he highlighted, the one thing the Fed hasn’t done is further expand its balance sheet. The next six weeks will be interesting in the run up to the US election, after which a lot will naturally depend on who will be inaugurated as President in January.
In the UK, the government are determined to both halt the continued spread of Covid-19 and keep the wheels of the economy turning. Whether such an outcome is achievable remains to be seen, but the new direction involves selectively re-applying some of the restrictions seen during lockdown, including a tightening up of rules for restaurants, pubs and bars.
Travel and leisure stocks would be among the losers from a return to some of the lockdown restrictions, and their share prices have been hit as a result. In Richard’s view, in times of crisis it is often the second plumbing of the depths that provides investors with an opportunity to become an aggressive buyer, as others capitulate and despair of there ever being a turnaround in fortunes. In this instance, Richard points out that the world is by definition six months closer to a vaccine now than when the pandemic first took hold around the world, so he would say this is not the time to abandon all hope for travel and leisure stocks. That said, he isn’t particularly bullish on the sector either and for example has elected not to take part in a rights issue for an airline group held as a small position in his strategy. For Richard, this is a time to assess company results as they are announced, take another close look at the balance sheets and cash burn, and decide which stocks will be able to survive through to at least the spring.
Richard Buxton – Head of Strategy, UK Alpha
Are there storms brewing in high yield markets?
High yield bond markets have experienced strong new issuance, although some struggling sectors are seeing a few deals pulled, said Leon Wei, Credit Analyst, Fixed Income. In the US, total new issuance is around $340bn which is 70% higher year-on-year. In Leon’s view, it’s clear that issuers are taking advantage of the fact that yields in the US high market are not far from their pre-Covid heights.
However, some of the more challenged sectors within high yield, and even investment grade, have lately had more trouble arise in completing deals. Leon highlighted the recent example of a German office and retail real estate business that tried to price a BBB bond a few weeks ago, but the deal got pulled partly because of the poor market perception of commercial real estate.
In the energy markets, he noted that the rally in high yield energy has gone slightly ahead of both the oil price and energy equities. This is despite the fact that credit fundamentals in the sector still remain relatively fragile. For example, according to Moody’s, five out of the ten high yield companies which have defaulted in August were in the energy sector. In the strategy, Leon says the team are focused on high quality energy credits and, apart from some short-dated yield-to-call special situations, they have not added to their exposure for some time.
Leon Wei – Credit Analyst, Fixed Income
Defensive sectors hit in emerging market sell-off
Emerging market equities had a strong start to the month, but month-to-date gains were wiped out by the wide market sell-off earlier this week, said Colin Croft, Fund Manager, Emerging Markets. Predictably, some of the worst impacted sectors included banks and commodities, as well as countries like Turkey, which are dependent on external funding.
What is more, some of the defensive sectors in emerging markets (EM) that previously held up well in previous bouts of volatility also got hit hard this time round (e.g. gold miners, computer game producers and convenience stores). Valuations in some of these areas were starting to look quite stretched, so Colin said this could be partly down to profit-taking. In addition, some of these names had been attracting lots of retail money, and retail investors may have been spooked by the headlines about the ‘second wave’ of Covid-19 and the greater restrictions that were being introduced in Europe.
In terms of commodities, oil prices were the worst impacted, partly on news of the imminent resumption of Libyan oil exports. Currently, Libya is only pumping 90,000 barrels a day (bpd) , but Colin said this could ramp up to 500,000 bpd by year-end and 1m bpd by next summer. At the same time, demand for oil is also taking a bit of a knock from tougher Covid-19 measures. While demand has returned in places like China, we’re likely to see a fall in demand in Europe at least going into year-end, in Colin’s view, which would push back recovery of oil prices further into next year.
Meanwhile, the energy transition in the transport sector seems to be accelerating, said Colin. We’ve seen strong sales forecasts from some car producers, and several governments such as the UK are bringing forward their targets for the abolition of new combustion engine sales. This should be positive for battery makers and producers of electric vehicle components, many of which are based in EM countries. As most EM countries are oil importers, overall, this transition in motor fuels ought to be positive for EM, in Colin’s view, though he acknowledges it would undoubtedly cause some problems for EM oil-exporting countries like Russia. Russia has sizable currency reserves providing some insulation, but it’s starting to look for new sources of revenue to allow it to maintain its fiscal discipline, including raising extraction taxes in oil and mining sectors.
Colin Croft – Fund Manager, Emerging Markets
Taking a shine to midcap gold miners
The best way to understand the investment opportunities today in midcap gold miners and the potential benefits of consolidation is to look back at the last bull market for gold, when the price rallied around 600% between 2001 and 2011, said Chris Mahoney, fund manager in the Gold & Silver team.
Back then, miners of the precious metal became overly bullish and undisciplined, taking on excessive debt and pursuing ill-conceived acquisitions and unsuitable projects, he said. When the price of gold fell in 2011, these companies were exposed. What followed, said Chris was a painful period of impairments, dividend cuts, cost reductions, management shakeouts and slumping share prices.
Today, the midcap gold miners in particular are well run, cost-conscious companies with low debt levels, and this was evident in the sector’s strong 2Q results even with the Covid-19 impact. In Chris’s view, midcap gold miners also are cheap relative to their large-cap peers on most valuation metrics, but that spread should narrow as investors shift focus from better known and bigger companies to the midcap names.
Chris expects to see additional consolidation in the industry, with benefits for investors, as larger gold miners acquire midcaps to boost reserves. Exploration spending was massively cut in the period of austerity after 2011, leaving gold miners with an average of 10 years of reserve life, half as much as copper miners. Buying assets of other companies is the fastest way to boost gold reserves, Chris said, adding that takeover premiums have typically exceeded 30% over the last decade and may move higher as demand for these golden assets triggers bidding wars.
Chris Mahoney – Fund Manager, Gold and Silver
Please keep an eye out for a variety of content updates from us, ranging from insights and views of some of the worlds leading fund managers, to general market updates and our own original content blogs.
We try to keep you updated with a wide range of different content to keep you updated, informed, and engaged.
Andrew Lloyd
25/09/2020
Research conducted by Royal London found that people without a financial adviser were more likely to be female, single, earning around £20-£30,000, and under the age of 35. As a 27-year-old single woman, I fall smack-bang into the middle of this category and was disappointed (but not surprised) when the statement presented itself to me. After some research and a lot of self-reflection, I now feel obligated to provide an insight into the intricacies of this finding from a personal standpoint.
‘I don’t earn enough to seek financial advice.’
Talking about money does not come easily for most of us. It is a personal matter and can feel uncomfortable to discuss. Despite this, it is very important that we do talk about the ‘m’ word. At times, my perception of my own finances has made me feel that I did not earn enough money to warrant financial advice. I did not have enough self-confidence to approach a professional from the financial industry. I think my pre-disposed view of a testosterone-fuelled, overly male-dominated Wall Street had led me to believe that investing was not particularly catered towards women.
I am now aware, however, that specialised advice from a professional adviser can help me set realistic financial goals – and reach them. Ironically, my previous perception of my financial status meant that I denied myself the opportunity to strategically grow my wealth in the first place. To back this up, Royal London and the International Longevity Centre UK (ILC) found that, in the space of just 10 years, customers who had sought financial advice were, on average, £47,000 better off than those who had taken care of things themselves.
‘I don’t have time to seek financial advice.’
A young woman living in the 1950’s and 60’s was typically expected to marry, have children, and assume the role of primary caregiver. Times have (thankfully) changed and for the most part, women can now progress into further education and a career of their choice – should they wish to do so. The ‘modern woman’ is her own person, has her own money, and can have it all. The only downside of this is that many women are required to perform a constant juggling act between family, friends, and career – often prioritising the needs of others before their own. Perhaps women of this day and age are just so busy living a full life, that they do not have time to seek financial advice?
As it turns out, we have plenty of time. On average, women live 5 years longer than men. Therefore, it makes sense for us to prepare for long-term financial stability and the best way to do this is with professional, preferably long-term, financial advice. One of Royal London’s key findings was that those who fostered an ongoing relationship with their adviser were up to 50% better off than those who had only received advice once.
‘I don’t believe that financial advice would benefit me.’
Money makes the world go round and most of us will experience ‘money worries’ at some point in our lives. New statistics from Fidelity International show that 47% of young women have had their mental health affected by financial worries, but only 12% surveyed would ask for help from a financial adviser. When I feel stressed or over-whelmed, I typically tend to seek advice from friends, family or even a work colleague. To improve my general well-being, I might go shopping, force myself to attend a spin class at the gym or perhaps even visit my GP if necessary.
This year, more than any other, has made me realise the importance of looking after my mental health. I recently realised that when I feel positive about my financial situation, I feel positive about myself. Good quality financial advice can improve emotional as well as financial well-being and the practice of sound financial planning in our 20’s and 30’s builds a strong foundation for a secure future.
And the uncertain times that we now find ourselves in makes the prospect of a secure future all the more appealing.
The year of 2020 has been challenging to say the least. Due to the Covid-19 crisis, the UK went into its first national lockdown on the 23rd March, and, by the end of April, my days had blurred into one self-isolated Groundhog Day. I had lost all sense of routine and was struggling to work productively from home. To add to this, my only form of contact with friends and family was via repetitive virtual quizzes. I was then furloughed and spent my days attempting DIY, and my nights battling anxiety caused by a looming threat of redundancy. It is now apparent that my concerns were not without rationale. New findings from the European Institute for Gender Equality and our Institute for Fiscal Studies indicate that women will be disproportionately affected by job losses as a result of the current economic conditions.
Bottom line; women have never been more in need of financial advice than they are now.
Women of the past fought for our right to vote. Today, we are still striving for equality in relation to the gender pay gap, and it now appears that we are stuck in a pensions gender gap too. Research undertaken by NOW: Pensions and the Pensions Policy Institute has revealed that women in their 60’s have an average of £100,000 less in their pension than men do.
For me, when it comes to a lack of women receiving financial advice; the worst part of it is that this time, we have nobody to blame but ourselves. I, therefore, implore all women to seek financial advice. You may just unlock your financial potential…
Chloe Speed
24/09/2020
Please see below the latest market insight from Karen Ward at JP Morgan, with particular reference to the ongoing complexities of Brexit.
An American colleague joined me on a call recently and was perplexed by the fact that I was talking about Brexit. “Isn’t Brexit done?”, he asked me. Alas, no. While the UK did officially leave the EU on 31 January, for the economy nothing actually changed since the UK entered into an 11-month period of transition. During this period, the UK and EU were supposed to agree on a future trade arrangement to commence on 1 January 2021. The clock is well and truly ticking.
Negotiations are proceeding slowly and significant differences still remain. At the root of the problem is the same issue that has plagued the discussion for the last four years. The UK wants to regain control – to become fully sovereign – setting its own rules and regulations overseen by British courts. However, the EU is not willing to grant significant access to the single market without guarantees that standards will not be undercut to gain competitive advantage.
So what happens next? Either the next six months will see a breakthrough and a free trade agreement (FTA) will be established or the UK will leave and trade on World Trade Organisation (WTO) terms.
Trading on WTO terms has been used synonymously with ‘hard Brexit’. What exactly does that mean? The short answer is potential tariffs, more customs paperwork for businesses that trade with the EU and potentially the need for the UK to be removed from EU supply chains if regulatory conformity cannot be guaranteed. It is these nontariff barriers that we would expect to have the most economic impact. There could also be significant ramifications for financial firms since the UK would lose its passporting rights – its ability to serve EU clients from the UK. Advocates for a hard Brexit argue that a clean break would allow the UK more flexibility in negotiating future trade deals with other trading partners, although any benefit from these agreements would still only be seen once these trade deals had been implemented, which is often a lengthy process.
What will happen and what will be the implications for markets? In our view, the announcement of a comprehensive FTA might see sterling rise to 1.45 against the US dollar. By contrast, in a no-trade deal scenario we see sterling closer to 1.10 against the dollar. Much weaker sterling would partially help the UK to cope with new trade frictions.
Our central expectation is that despite ongoing near-term sabre-rattling, by year end pragmatism will prevail and a relatively narrow trade deal will be agreed. When ‘Brexit’ was added to the English dictionary, the word ‘fudgery’ should also have been included.
We expect a significant amount of ‘fudgery’ in order to get a partial trade agreement done. This may, in fact, involve highlevel agreements that disguise what is essentially a transition to iron out the finer details. Such a narrow trade deal will likely still be disruptive to economic activity in the EU and the UK over the long term. But we expect various arrangements to ease the near-term burden of the change for both sides. We expect that both sides will want to minimise the day 1 disruptions given the extent to which both economies are still struggling to overcome the Covid-19 recession. Therefore, changes may well be phased in over time, spreading the economic cost over a number of quarters if not years. The UK could thus claim the sovereignty to set their own rules and standards without initially making substantial disruptive changes.
While this outcome is our central expectation, there are significant risks around it that investors should be mindful of. Sterling may be particularly volatile and, with almost 80% of revenues coming from abroad for the FTSE 100, this will also have implications for the stock market, since higher sterling could put downward pressure on earnings and vice versa should sterling fall, all other things being equal. However, we caution against relying too heavily on the FTSE rallying in the event of a hard Brexit as a disorderly Brexit would be likely to impact both UK and EU activity negatively, depressing some of the overseas earnings that matter to UK companies.
We will continue to provide the most up to date information on the markets and economy. Please check in with us again soon.
Stay safe.
Chloe
24/09/2020
Please see below for the latest blog from Legal and General’s Investment Management Team regarding their ‘key beliefs’ regarding the markets:
Forward looking
It may seem difficult when faced with the latest political developments and a second wave of COVID-19, but investors need to be forward looking. If markets are indeed relatively efficient pricing mechanisms, we shouldn’t focus too much on what’s happening today; instead we need to think about what could happen tomorrow and beyond.
As with all Key Beliefs emails, this email represents solely the investment views of LGIM’s Asset Allocation team.
Pent-up demand unleashed
From an equity perspective, the losers from social distancing have been hit hardest by the pandemic. But if and when consumer behaviour normalises, these stocks should also benefit disproportionately.
In the spring and summer, such a recovery felt too distant for the travel and leisure sector, so we preferred other laggards like autos and small-caps. But as time has passed, we now expect generally positive macro news over the coming three to nine months (on vaccines, rapid testing and regulatory decisions) to start becoming a tailwind for this sector as well.
While we have no edge on the specific events, market expectations do not look excessive: sentiment is still bearish on the sector and performance has remained underwhelming and stuck in the middle of the post-pandemic range.
A vaccine should help these stocks in two ways: through de-risking the future path of their earnings, and through upgrades to earnings estimates if consumers resume their past behaviours faster than expected. This has already happened for other sectors, perhaps helped by some pent-up demand after the lockdown.
That’s not to say there are no risks to this trade. A greater-than-expected second wave could further delay a restart, customers could reject the changes made to the travel and leisure experience, or outbreaks on cruises could set back the wider sector.
But we believe that being closer to a potential turning point in the news flow, without having seen any meaningful outperformance for the sector, makes the risk/reward dynamics attractive enough for a first step.
Powerful gambit
European Commission President Ursula von der Leyen gave her annual State of the Union address last week. Invoking Margaret Thatcher in an argument with a Conservative British Prime Minister was a bold but powerful gambit. In the words of the original Iron Lady back in 1975, “Britain does not break treaties. It would be bad for Britain, bad for relations with the rest of the world, and bad for any future treaty on trade.” The sense of frustration with the shenanigans in Westminster is obvious.
It is tempting to think that the latest dispute is terminal for the prospect of a successful conclusion to trade talks. But the nature of brinkmanship is that it drives matters to the brink. Almost all European negotiations go to the 11th hour or beyond, so it is pretty hard to infer anything definitive at this stage.
If forced to pick a direction for sterling from here, we think appreciation is more likely than further depreciation. Portfolios naturally heavy on foreign currency therefore need to be increasingly mindful of a “rabbit out of the hat” moment driving the pound higher.
For non-Brexit obsessives, von der Leyen also had some interesting things to say about green bonds and carbon objectives. The EU is set to embark on an unprecedented issuance spree to finance the recently agreed Recovery Fund. Up to 30% of the planned €750 billion will be raised via green bonds. In the short term, we think the surge of EU issuance risks driving up yields in ‘semi-core’ European nations like France. Over the longer term, given that the green-bond market totals around $400 billion outstanding today, this will really bring the asset class into the mainstream.
Off the charts
We have highlighted the TIM Monitor a few times in previous Key Beliefs as one of a number of quantitative risk environment indicators that we use. The monitor aims to provide a characterisation of the current market environment and the likelihood of extreme losses going forward based on the combined information from two indicators: the Systemic Risk Index, which measures equity market fragility, and the Turbulence Index, a measure of ‘unusualness’ in global equity returns.
Needless to say, equity markets proved to be both fragile and extremely unusual in the first quarter, so much so that the TIM Monitor was quite literally off the charts. The monitor moved into ‘Alert’ territory on 25 February, with the S&P 500 down by around 7.5% from its peak at that point. After that, the S&P 500 fell a further 30% to its low on 23 March. The monitor remained in ‘Alert’, with the Systemic Risk Index remaining uncomfortably high, until 17th August when it finally switched back to ‘Warning’, almost exactly at the time that US equities returned to their previous highs. So, it was a timely indicator to get out of equities, but a bit slow to get back in again.
The length of its tenure in ‘Alert’ territory in part reflects the fact that a small number of key drivers propelled the market back up again – swift and comprehensive monetary policy responses over the past decade have had a tendency to do exactly that in times of stress. But we must also acknowledge that it is partly down to how the Systemic Risk Index is constructed, as it is an intentionally (sometimes painfully) slow-moving indicator.
Within an investment process involving judgement, these types of frameworks can be extremely useful in providing a different lens through which to view the world. Each one comes with its own nuances, however, and hence we believe they are best used in combination with other metrics rather than in isolation.
Detailed and focussed opinions from market leading investment managers such as Legal and General can be a useful addition to your overall view of the markets.
Please keep reading our blogs to ensure your holistic view of the markets is well informed, diversified and up to date.
Keep safe and well
Paul Green
23/09/2020
