Please see below up-to-date commentary from Brewin Dolphin, received late yesterday. The article provides insight into mixed market performance with Covid-19 and Brexit developments noted as current contributing factors.
Equity markets were mixed last week as markets struggled to gain traction amid a flow of (mostly) worrying news. There was the worsening second wave of Covid-19 in Europe and the announcement of tighter restrictions on socialising in the UK. Then, a potential hitch with the AstraZeneca vaccine, added to increasing worries of a no-deal Brexit. On the financial front, perhaps the most remarkable development was the 3.5% fall in sterling which likely helped the FTSE100 outperform its international peers over the past week.
Last week’s markets performance*
• FTSE100: 4%
• S&P500: -2.5%
• Dow: -1.66%
• Nasdaq: -4%
• Dax: +2.8%
• Hang Seng: -0.77%
• Shanghai Composite: -2.83%
• Nikkei: +0.86%
*Data for the week to close of business, Friday 11 September.
A mixed start to the week
Equity markets in the UK and Europe turned in a mixed performance on Monday despite encouraging news about the resumption of the AstraZeneca/Oxford University vaccine trials in the UK.
The FTSE100 closed 0.1% down on Monday and the more domestically focused FTSE250 rose by 0.7%. Sterling rose 0.76% against the dollar to $1.289, and by 0.42% against the euro to €1.085.
In Europe, the pan-European Stoxx600 gained 0.15%, the German Dax fell by 0.07% while France’s CAC-40 closed up by 0.35%.
In the US, however, the positive vaccine news from the UK helped boost sentiment, as the Dow closed up by 1.2%, the S&P500 rose by 1.27% and the Nasdaq rebounded by 1.87% to 11,056.65.
Analysts said hopes about an early vaccine were tempered by concerns about rising Covid-19 cases in the UK and Europe leading to tighter suppression measures, with a consequent dampening of economic activity.
In early trading on Tuesday morning, UK shares were heading up.
Brexit is back
The developments over the last week have suggested an increased risk of a no-deal departure. And just as in previous bouts of Brexit-related stress, the worse things go, the greater the pressure is on the pound. The fortunate thing from an investment perspective is that this tends to be supportive of UK bonds (which perform inversely to the UK economy), and also UK equities, because of their inverse sensitivity to the level of the pound. In other words, when the pound falls, all other things being equal, most UK equities rise.
This might seem counterintuitive, but the reality is that the sensitivity of even UK equities to the UK economy is generally low and mostly limited to a small number of sectors, such as retail, real estate, home construction and banks. More broadly, the overall market tends to be more exposed to the overseas currencies in which its revenues are denominated. For example, around 75% of the earnings for companies in the FTSE100 come from overseas and so are denominated in foreign currencies. Therefore, when the pound falls, these earnings are worth more in sterling terms and this helps UK equities.
Overseas equities, unsurprisingly, are even more inversely sensitive to the level of the pound as they are both denominated in foreign currency and economically linked to revenues received in other currencies.
Below we show the % change in trade weighted currency, the top graph shows 2015 to present and the bottom chart shows the period from 15 May 2020 to present.
What this means
All of which means that, ultimately, we don’t see Brexit as a material investment risk. Paradoxically, the greater issue for us is how to protect wealth when Brexit risks subside because, under those circumstances, we would expect to see the pound rise and bonds (and possibly equities) fall – again, all other things being equal.
So how do we see Brexit developing? It seems likely that the current standoff is another episode of the brinksmanship that has been exhibited throughout the last four years. The intention of the government is to pressure the EU into making some concessions on fishing and, most notably, state aid. Most outstanding issues between the EU and the UK seem reconcilable, but the state aid point is one the UK government seems to want to push. Why? It seems like the government wants to ensure it can do everything it can to support strategically sensitive industries such as technology and renewables. This idea of a “Made in UK” strategy to match the “Made in China 2025” strategy is what the European’s are afraid of. It seems likely that, when push comes to shove, the UK will be forced to find a way of discreetly backing down – but we can’t be sure.
This also comes with an adverse trend in relative Covid-19 performance as well. America’s renewed surge in cases which began in the Midwest has failed to gather pace while some large states are seeing further improvement. Progress is not universal, however, and as we can see from Europe, a true second wave is likely in the US at some point. But for now, the US case growth numbers are improving which is helpful for Donald Trump as we approach the election in November.
Case growth in the UK, on the other hand, has accelerated. This prompted the government to impose new restrictions that came into effect from Monday to great consternation from the back benches. Evidence continues to point to Covid-19 as a continuing threat with the low rate of hospitalisations during France’s second wave now beginning to pick up. The concern here is that young people are spreading the virus amongst themselves and then introducing it to older generations of their families.
Covid-19 and your investments
Regarding the investment risks of a second wave of Covid-19, we believe that investors already expect successive waves until such time as there is a widely available vaccine. The question from an investor’s perspective therefore is not so much whether further waves come, but what the impact is on perceived valuations.
Understanding how the market reacts to that is not trivial. However, we should distinguish between what we saw in the early part of 2020 which was a shock, from what we might see in future periods, which will be more of an evolution of a known risk.
When we had the shock in March it was largely because the structure of the policy environment and the market were both set up for late-stage economic expansion. That is quite typical for the entry into a recession and is the reason that equity markets react so poorly to the onset of recessions.
On a valuation basis, the loss of a year or two’s worth of earnings is bad news but would not justify the falls seen earlier in the year – hence markets were able to rebound substantially.
With Covid-19 much more of a known-unknown, and with market expectations of ebbing and flowing regional measures to try and slow those waves, we acknowledge that Covid-19 remains an important factor for the market, but it should form part of the ‘wall of worry’ that markets often find themselves climbing.
Wall of worry
The cliché about climbing the ‘wall of worry’ describes the way in which markets are often resilient in the face of known risks. It assumes investors gradually become resigned to the fact that these issues will be resolved in due course and reflects the way in which the overly cautious gradually get sucked into the improving narrative. It is helped by such circumstances also tending to coincide with periods when monetary policy is very supportive.
One more handhold on that wall came from the news that the testing of AstraZeneca’s vaccine has been paused. Although one of the front runners, this was not the only candidate. However, over the weekend it emerged that the trial would resume in the UK and India, but it remains paused in the US.
Also providing a great deal of angst is the planned end to the furlough scheme next month. Chancellor Rishi Sunak is under a great deal of pressure from lobbyists and trade unions to extend the scheme further to prevent a “tsunami” of job losses this autumn.
An extension would not be without international precedent. Germany has announced an extension to its Kurzarbeit scheme, which gives financial aid to employers while allowing them to reduce employees’ hours. It had been scheduled to finish in March 2021 but has been extended for another year. France has also extended its version of the furlough scheme but has tweaked the rules so that employers must reduce hours for workers rather than keep them off work altogether. If the British government is going to follow suit, it is leaving it late.
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