Please see below an update received late yesterday afternoon from Royal London which details their current Market View and Economic Viewpoint:
“The remarkable run of the global equity market continued in August, reaching all-time highs led by the US. The rally has been supported by signs of recovery in underlying economic data and progress in the development of vaccines and treatments for Covid-19. While there was a significant market sell-off at the end of last week, led by technology stocks, US equity indices remain markedly higher than they were at the start of August.
Equity markets were relatively calm for most of August. The VIX index, a measure of expected volatility based on S&P 500 index options, spent most of August hovering around 22 (a six-month low). However, the market correction at the end of last week caused the index to surge to around 37.5 although this has declined towards 30 as I write. For many, US equity markets near all-time highs will seem bizarre, but as I noted in March, markets are forward-looking, and just as they fell sharply as the uncertainty of Covid-19 emerged, so in response to the record monetary and fiscal stimulus they are taking the view that ultimately, there will be a substantial economic rebound. What is interesting is the acceleration of certain trends – notably technology-related areas such as digitalisation. While stocks will see the normal ebb and flow in sentiment, there can be periods where markets over-extrapolate trends, and this can manifest itself in higher price multiples that investors are prepared to pay to own assets with exposure to that trend. While there has been some evidence of these trends starting to emerge in part of the technology complex, underlying earnings growth and cashflow generation have been strong this year, but when this comes with multiple expansion, we need to approach this appropriate caution.
The risk-on sentiment seen in equity markets was replicated in government bond markets, with yields surging globally. Within this, European government bond markets strongly outperformed, while the UK gilt market lagged on anticipation of a massive supply of long-dated gilts over the next few months. One of the key strategies for our government bond funds this year, given the many uncertainties for investors, has been to embrace tactical, rather than strategic, trading around supply events. The next few months should provide ample opportunities for that approach.
Within investment grade credit, spreads (the yield difference between corporate bonds and government bonds) are now only about 0.2% wider on the year, with the average spread 1.25% at the end of August, though there is a lot of sectoral variation within this. Financial bonds (banks and insurance) have been notably strong in recent weeks, which have benefitted our credit portfolios given that they are typically overweight in this area and in particular subordinated financials. The high yield credit market has performed particularly well since the market crash in March, with August being no exception. It looks likely to have been one of the most significant months of issuance ever, with companies keen to take advantage of the high level of demand in the market. Periods of significant corporate issuance are often supported by increased risk appetite for the asset class but can see investors being prepared to accept reduced covenant protections. As fundamental investors we need to be especially diligent when these trends start to emerge and position our high yield funds accordingly.
As we’ve said before, the coronavirus pandemic has changed things forever. Our autumn investment series webinars at the end of September have been put together to look at how these changes will play out in various asset classes. We’re also providing an update on how RLAM functions, not because this is intrinsically interesting, but to give you confidence in how we are operating and have adjusted to this new world. In addition, I’m delighted that we will have Andrew Neil doing a session for us. Andrew has a unique insight into the political process here in the UK. Ten years ago there was an argument that politics mattered less given the consensus that existed at the time. In an age of Brexit and Coronavirus, that is certainly not the case, and I’ll be listening to what Andrew has to say with great interest.”
RLAM Economic Viewpoint
The months of economic recovery post-lockdown, into the early part of the summer were strong, bolstered by the release of pent-up demand. The current phase of the recovery looks more challenging and the pace appears to be slowing in many places. In recent weeks, data has been more mixed. US and euro area business survey data for August indicated growth, but with some survey indicators rising and some falling – sending mixed signals on whether growth is slowing or speeding up. Higher frequency mobility indicators have flattened in several countries over July and August. ‘Hard’ data for July, such as retail sales and manufacturing production, suggest that the pace of growth slowed in the US and euro area, although the latter is not yet available in the euro area. China’s business surveys suggest that the recovery continues, but the pace of improvement in ‘hard’ data series like retail sales has slowed.
Several factors seem likely to help hold back the pace of recovery, especially until an effective vaccine is widely available:
- Mandated social distancing;
- Damage done/scarring – relating to permanent job losses, permanent business closures and household/business balance sheet damage;
- Fear – of the virus itself, but also of shutdown risks and related risks to job security and around the outlook for the return on any planned investment.
The progress of the virus will affect these (new case numbers have fallen in the US, but are rising in Europe). Governments have a direct role to play in 1); have pumped in a huge amount of economic policy support to limit 2); and through ongoing public health measures and economic stimulus, can help dampen 3).
Over the last few weeks, the role of governments is one area where risks are building, particularly in the US. US monetary policy remains accommodative and the FOMC’s recent adoption of an average inflation targeting framework further underscores that they will be in no hurry to take back that stimulus. Fiscal policy, however, has disappointed. There was some expectation that US politicians would agree a fiscal package earlier in the summer to offer at least some continuity after the provisions of the CARES Act rolled off – in in particular, the boost to unemployment benefits. With election campaigning now in full swing, it is less clear that both sides will be able to come together and pass a package. Another government funding deadline approaches at the end of this month, bringing the prospect of shutdown risk too.
Here in the UK, there are reasons to worry as well. Some temporary government interventions have been a big boost/support to activity, but it is not clear how well the economy will do once they are unwound. Eat Out to Help Out has been a success in getting people eating out, although it is too early to judge whether the effects will last. The heavily used furlough scheme is discontinued entirely in October. So far, the UK unemployment rate has stayed at very low levels as take up of the scheme has been high. That will have helped to shield many households from the effects of the crisis. As that support is unwound, more job cuts are likely as firms reassess their finances. It was notable that in the – generally strong – August PMI business survey, that the employment component remained weak. In their press release, compilers IHS/Markit comment that “lower payroll numbers were primarily attributed to redundancy programmes in response to depleted volumes of work and the need to reduce overheads before the government’s job retention scheme winds down”.
As for inflation, the data has yet to give a clear steer on whether the worst of the deflationary effects of the crisis are behind us. Across many developed economies, July inflation data surprised on the upside. However, euro area inflation went on to surprise on the downside in August, recording a first negative year-on-year print since March 2016 and the next print of UK inflation will incorporate the effects of the VAT cut and Eat Out to Help Out. As for how deflationary/inflationary the crisis will ultimately prove to be, the odds on an inflationary outcome have arguably risen after the FOMC’s change in monetary policy framework. However, “likely” aiming for “inflation moderately above 2% for some time” after inflation has been persistently below 2% – as has been in the US – is not a green light for a high inflation environment. Several other factors, including a boost for online retailing from the pandemic, are likely to work in the opposite direction on inflation.
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