Please see below blog received from Legal & General yesterday afternoon. We have followed the markets’ reaction to both negative Covid-19 statistics and positive vaccine news. This commentary focuses on the effects of British and US politics on investments.
Cummings and goings
Last week, Downing Street’s internal soap opera spilled into the public domain. With the departure of Lee Cain and more importantly Dominic Cummings, two key advisers to Boris Johnson who were instrumental in the Vote Leave campaign, there are now questions about the future direction of policy.
In particular, there is speculation that the government may need to make significant compromises to get a Brexit deal over the line in the coming few weeks. Clearly progress has been made in some areas but, as both sides willingly admit, significant differences remain on some seemingly intractable issues such as fishing rights, the level playing field, and governance.
Another factor is the interaction between the UK and the new US President-elect. Joe Biden made clear his concerns that the (recently defeated) Internal Market Bill could undermine the Good Friday Agreement. But to what extent could this influence negotiations with the EU?
One line of reasoning is that the UK may need to compromise with the EU if it looks as though a transatlantic trade deal will be less of a priority to a Biden administration. But, regardless of the occupant of the White House, it was never likely that a deal with the US would be straightforward. It is therefore unclear whether the change in US government will have a material influence on the UK’s negotiating stance.
The market consensus is that a last-minute deal can be reached. Given the importance to our sterling-denominated long-only funds (where any unhedged foreign-asset exposure results in a short sterling position), we continue to watch developments closely.
Tick, tock tech?
The positive vaccine news last week was like a shot in the arm to much of the equity market. Not so for the tech sector, however, which has performed strongly through the lockdowns. Yet while a vaccine – hot on the heels of Biden’s election victory – may bring about some market normalisation and appear to dampen the relative attractiveness of tech in the short term, the structural trends that have been the backbone of our longstanding tech position look set to continue, in our view.
Despite the rally this year, valuation is not a large concern for us. Tech stocks do trade at a premium to the market, but the sector’s outperformance has been driven by superior earnings growth rather than any re-rating, a big difference compared with the 1990s tech bubble.
And while Biden and the Democrats may be regarded as a headwind for tech, governing with a (likely) split Congress probably means a continuation of the status quo and very little policy that could significantly move markets. There will likely be an acceleration of antitrust investigations into big tech, but so far such investigations have delivered somewhat toothless conclusions.
Biden did not show a particular passion for tech regulation either before or during the campaign, and centrist appointments to his government would signal a more market-friendly approach than some feared earlier in the year (the decision to select Kamala Harris instead of, for example, Elizabeth Warren as vice president is a prime example).
Furthermore, over the medium term the US has little incentive to over-regulate domestic companies given tech’s importance in the broader geopolitical rivalry with China.
The tech selloff early last week thus gave us an opportunity to top up our overweight in the sector, but we remain alive to the concentration risk this position carries. Within portfolios we continue to balance this risk with positions in some of the least-loved corners of the equity universe, such as European travel and leisure.
This time is different?
Back in April (which feels like a lifetime ago), we downgraded our medium-term duration view to underweight. With the post-election/vaccine selloff, we have taken the first steps to moving that view back towards neutral.
Taking the Federal Reserve’s (Fed) ‘dot plot’ at face value implies that rates will be on hold until the end of 2023. From that point forward, if we assume a similar hiking cycle to the last one (i.e. once per quarter), we get to an average Fed funds rate of 0.5% over the next five years. The last cycle was admittedly slower than previous iterations, but given the Fed’s recent switch to average inflation targeting and its repeatedly quoted ambition to wait until inflation is above target on a sustained basis before tightening policy, there is an increased chance that the central bank will again hike gradually, all else equal.
Further along the curve, the difference between 10-year and five-year yields (also around 0.5% currently) is in line with the average of the past five decades. It follows that, with the front five years of the yield curve in line with the dot plot and the slope of the next five years back to ‘normal’, a neutral view is consistent with a 10-year treasury yield of 1%, a level that it is gradually approaching.
One key risk is that the curve steepens further on ‘crowding out’ or supply concerns in the event of another big fiscal package. That has become less likely since the US election (notwithstanding the runoff for Georgia’s senate seats), although the current COVID-19 wave in the US could focus minds on Capitol Hill.
Even if we do see a stimulus package between now and the end of the first quarter of 2021, it feels as though $1 trillion is the tipping point between a positive and negative surprise on this front.
As we move into the final weeks of what has been an eventful year, we will continue to publish up to date market analysis and relevant content. Please check in again with us soon.
Stay safe.
Chloe
17/11/2020