Financial markets are normally robust, having learnt the hard way from past lessons of setbacks, such as Black Monday 1987 and the Financial Crisis of 2007-2008. However, very few would have foreseen the full extent of the pandemic and its consequences to the financial system. After the extreme global economic decline witnessed in mid-2020 there had been a meaningful recovery to the end of 2021 with a return of stability, but the adjustment to a post-Covid world was to follow.
So far, 2022 has been a tough year for investors, an already weakening global economy has been further upset by Putin’s war and supply squeezes creating an unpredictable environment for investors with very few places to hide. The pickup in inflation since the pandemic has forced central banks around the world to end the period of easy money and tighten conditions by raising interest rates to stop inflation from becoming embedded in the system. This action has been met with various degrees of success so far.
This rising rate environment has been painful for both equities (stocks and shares) and bonds (loans)*, as investors reprice the relative attractiveness of these assets against a higher “risk free” rate offered by central banks. Commodities have offered some positive returns. However, investors have needed to be selective here. Energy has been positive a performer but areas such as metals and lumber have seen large falls this year and invariably all commodities have been very volatile. Even cash holders have struggled in real terms with inflation outstripping interest returns for savers; something that we have got used to in recent years and are likely to endure with for some time to come.
Against this backdrop it is understandable to feel nervous, particularly when news flow in the UK centres around unstable government policy, the cost-of-living crisis and unpopular budgets from our numerous Chancellors in recent months. However, it is important to be mindful of the benefits of long-term investing both in managing volatility and in combating inflation.
Timing the market is notoriously hard as investments tend not to move solely in a straight line. Large moves in one direction are often followed by large moves the other way, as evidenced this quarter when markets rallied in July thanks to some weaker economic data (which perversely is a positive for assets at the moment) before changing course, as Central Banks doubled down on their rigid approach towards combating the economic downturn. Thin trading volumes have exacerbated the share price moves this year and it currently doesn’t take a lot to move the dial. This makes market timing even harder and it is easy to get caught out.
Therefore, although it can feel uncomfortable, it is prudent to ride out these bouts of volatility by remaining invested in a diversified portfolio rather than crystallising a loss and looking for another entry point. An example of this is the recent investment performance. Mid-October saw a sizable downturn. Had we disinvested then, for no reason other than fear of worse to follow, we would have missed out on a subsequent rally in recent weeks. Although it is a phrase used all too often, it really is about “time in the market rather than timing the market”.
Inflation is in everyone’s minds at the moment and for investors it is the biggest long-term threat to returns. In the near term, Central Banks face the challenge of bringing it down from its current highs without causing a deep recession, again with varying degrees of success so far. It is likely that headline inflation (a measure of the total inflation within an economy) will come down from the current extreme levels without any further Central Bank intervention as the impact of energy rises over the year will experience reversal. Core inflation (the long run trend in the price levels, excluding food and energy) may prove more lasting and Central Banks will be keen to stop this becoming embedded in spiralling wage costs. Even so, we may be in for a higher period of inflation than we have been used to in the last 20 years. While there are assets that people look at to hedge inflation risk, such as Gold or index linked bonds when conditions are right, one of the most effective ways to combat long term inflation is to remain invested in equities where the companies can pass on their increased costs to consumers. Historically, equities have offered a real return to investors above inflation, though they do so with higher volatility so a long-term investment time horizon is important.
Rising interest rates have been painful for bond investors this year and indeed for traditional 60/40 (equity/bond) portfolios as these two asset classes (that historically have had little correlation with each other) have fallen at the same time. Going forwards this higher rate should also allow bonds to play more of a defensive role in portfolios as if the overall economic environment deteriorates significantly and Central Banks begin to lower rates again. The capital value of the bonds should increase providing support to portfolios when equities will likely be under pressure.
Lastly, it is important to highlight that a lot of the negativity expected in the future has already been priced in to assets and that while things could deteriorate further than the current base case, the downturn could equally be less severe than markets suggest and as July (and the last two weeks) showed, investments can rally quickly from here. Investment experts believe that having a well-diversified portfolio is the best way to navigate these testing times and that over the longer term this should lead to solid returns ahead of inflation.
Important Information
This material has been written with Tatton’s contribution and is for information purposes only and must not be considered as financial advice.
We always recommend that you seek financial advice before making any financial decisions.
The value of your investments can go down as well as up and you may get back less than you originally invested.
* A bond is simply a loan taken out by a company. Instead of going to a bank, the company gets the money from investors who buy its bonds. In exchange for the capital, the company pays an interest ‘coupon’, which is the annual interest rate paid on a bond expressed as a percentage of the face value. The capital borrowed is repaid in full at the end of the agreed term.
Bad news filled the airwaves last week. Faltering global growth, higher inflation forecasts and rising interest rates set a dour tone – capped off by a geopolitical crisis in Taiwan. UK investors were struck by the Bank of England’s dire warnings: a 13% inflation peak and a protracted recession are now in store for Britons, according to Governor Andrew Bailey. Predicted to last for five quarters, the looming UK recession is set to outlast the one following the global financial crisis in 2008/09.
Yet despite all that gloom, capital markets have been in surprisingly good spirits. Equities have rallied since the start of July, and bond yields have fallen. As a result, markets have more or less recovered all of their June losses. So, why are investors so unfazed by the current bad news? Judging from bond markets, the feeling is that we have reached peak global inflation. Oil prices have started falling and the actions of oil producers themselves point to a belief that current prices are unsustainable. Supply chain bottlenecks clogged by the pandemic are also improving, while consumer demand has clearly taken a hit from the cost-of-living crisis. The thought is that this will cause a reversal of central bank policy sooner than previously expected, with implied US rates peaking by the end of this year. Investors have essentially given central banks – particularly the US Federal Reserve (Fed) – a vote of confidence. Its policies are expected to prevent a dangerous wage-price spiral while maintaining the economy at a decent level. What’s more, middle-class consumers still have savings to fall back on, while jobs remain plentiful and businesses are more financially sound than in previous downturns. Recessions in most regions are expected to be shallow and brief, while the US might avoid one altogether.
Monetary policy works on a very long lag, meaning that tweaks to interest rates now will only have an effect a year or so down the line. But if bond markets are to be believed, inflation will already be largely under control by then – meaning further tightening would be overkill. Central bankers want to tame inflation right now, and the only way they can think to do that is by affecting consumer and business behaviour. They will hope that pessimism will stop employees pushing for higher wages, bringing down cost pressures. That is the best-case scenario, and the one markets are currently betting on. Such optimism in bond markets was the main reason for July’s uptick in equity prices – as falling yields made stocks comparatively more attractive. But that positivity is itself a little concerning, as it makes asset prices vulnerable to worse-than-expected news.
There are still many risks to the overall outlook, which are arguably not properly priced-in. Europe is particularly at risk, facing energy shortages and sharply higher costs this winter. This should bring consumer demand down further and eventually cool inflation, but that could take some time. The main source of Europe’s woes is gas supplies, which are very hard to adjust in the short-term, and are highly susceptible to Russia’s war in Ukraine. European businesses could be the hardest hit, as they have less sway over electoral outcomes and are therefore lower down on politician priority lists.
Markets nevertheless seem to think the inflation battle is already won, and there is a clear path to economic recovery. But none of that is certain, and there are many political obstacles that could get in the way. Governmental paralysis in Britain and Italy could prevent decisive policy action (Conservative MPs have already questioned the Bank of England’s independence in response to its dire forecasts), while US-China tensions over Taiwan are a serious and perhaps under-appreciated risk to global growth. Negative news flow, particularly around energy supplies, could severely dampen market sentiment from here.
Oil and gas prices, buoyed by pandemic supply issues and then catapulted skyward by Russia’s invasion of Ukraine, have generated truly astonishing results for the world’s biggest energy companies. Centrica, the owner of British Gas, recently reported profit growth of 500% year-on-year for the first half of 2022. Meanwhile, Shell posted its best ever quarterly profits for Q2 and BP its highest profits in 14 years for the same period. All of this comes while Britons face eye-watering rises in energy and fuel costs. Naturally, the disparity has led to a great deal of negative media coverage.
These profits have naturally benefitted share prices. On a net total return basis, unsurprisingly, Energy is the best performing sector over the last year, by some distance. Bloomberg’s energy index is 28.4% up from a year ago. Utilities, the only other sector to post positive growth over that time, are up just 5.3% by comparison. These moves are made all the more impressive by the negative equity market backdrop in that time. The rise in ‘risk-free’ rates has dampened equity valuations across virtually all industries, and energy is no exception. In fact, on a forward price-to-earnings ratio, energy company valuations have come down more than any other sector. The fact that energy companies have posted the best returns while dropping to the lowest valuations is astonishing, and shows how sharp the recent energy price shock has been. But it also shows investors are much less optimistic about the long-term prospects for energy companies than current results might suggest. Some of this is down to the likely political response: the UK government has already announced a windfall tax on oil and gas companies, and the sharper the contrast between struggling households and booming energy giants gets, the more likely we are to see further taxes – and not just in the UK.
The deeper reason for falling energy valuations, though, are likely to be structural. Russia’s war and the ensuing sanctions delivered the biggest price shock to global energy markets since the 1970s OPEC embargo. Oil and gas supply lines between Russia and the West have been battered and may not ever recover, leading to a sharp squeeze in prices. But over the longer-term, prices are less about what goes where and more about the balance of aggregate supply and demand. That balance has not been fundamentally changed by Russia’s invasion. Russia has a short-term interest in squeezing its European customers – particularly Germany, which has been one of the hardest hit by constrained gas supplies – but has no interest in reducing its oil and gas production over the long term. It has already found many willing buyers in Asia, and will inevitably want to get back to full production and export volumes when it can. Then there is the demand side. The pandemic recovery saw a sharp burst of pent-up energy demand, but this has since cooled off significantly. With looming recession fears, this trend is set to continue. What’s more, the incredible rise in energy prices is already destroying end demand. Come winter, this is likely to mean intense energy saving efforts – with communal heating and power-cuts already being discussed in Germany.
The current price shock will also have implications for the future. Fossil fuel investment measures have been drawn up for the UK and US – which will increase supply some years into the future. More importantly, there is a clear political drive toward increasing renewable or even nuclear energy production. This is part of a much longer-term move away from oil and gas, and the cost-of-living crisis that is rooted in our fossil fuel dependency goes back, has significantly heightened the sense of urgency that already existed from the global warming CO2 side of things. Inevitably, this dampens the long-term outlook for oil and gas demand.
Fossil fuel producers are well aware of this. At their most recent meeting, OPEC+ countries agreed a minimal increase in production despite a seemingly huge price incentive to pump more. This suggests a recognition that current price levels are unsustainable in the face of rising interest rates and a slowing global economy. On the current trajectory, oil supply is likely to outstrip demand within the next four years. As producers see it, increasing production now will just make them more vulnerable to lower prices in the future. With this in mind, lowly valuations for booming energy companies are to be expected. Record oil and gas profits are here for a good time, but not a long time.
The first quarter of 2022 saw global equities falling -2.6% for sterling investors as inflation worries, geopolitical tensions and central bank tightening unsettled investors. In March, most major equity markets rebounded, but have only partially repaired the losses of the previous two months. The two major events that drove the quarter were a shift in the so far accommodative monetary policy approaches as spiking commodity prices created inflationary pressures and Russia’s invasion of Ukraine.
In regional terms, the UK equity market ended Q1 2.9% higher, outperforming its peers as it benefited significantly from the commodity rally and the escalation of energy price movements since the start of the year. In the monetary policy front, last year, the Bank of England was the first major central bank to raise interest rates in December and to indicate that further hikes would follow. The bank followed this up with another rate rise in March, leaving benchmark interest rates at 0.75%.
The main US market fell -1.9% (-6.3% for the US technology sector) as rising yields affected the more yield-sensitive growth and tech sectors. Energy and utility firms, however, erased some of the indices’ losses as they saw strong performance on the back of the Ukraine Russia situation and the commodity rally that the escalations caused. European equities fell sharply in Q1, -7.4%. Even though there has been some relief following the announcement that the US will supply the EU with American Liquefied Natural Gas, a deal that aims to reduce the region’s dependency to Russian energy, uncertainty around supplies remains and consumer sentiment remained low over the quarter.
Emerging Market equities dropped -4.3% over the quarter. China, the main driver of performance in the index, faced slowing economic activity as the region struggled with a new covid outbreak, which forced local authorities to impose strict lockdown measures. Japanese equities also ended the quarter down -3.9%. In contrast with most of the world’s central banks, which have started tightening policies to tame the high inflation levels, Bank of Japan announced in March a plan to expand its quantitative easing program.
In commodities, oil prices soared 38.5%. Prices were already at all-time highs as global economic recovery was well underway following the March 2020 pandemic outbreak, but the volatile situation between Russia and Ukraine created further anxiety around tight global supplies. Looking at the next quarter, focus will remain on monetary policy and inflation while we monitor geopolitical tensions.
DEFENSIVE - Portfolio Activity: Asset Allocation & Fund Selection
Asset Allocation
There were no changes in the asset allocation this quarter. Throughout the quarter we maintained our equity overweight position. We continued to hold our overweight position in European and Emerging Market equity markets, and we also retained our allocation to the UK large cap market. In fixed interest, we kept an underweight to bonds.
Portfolio Performance & Underlying Holdings
It was a negative quarter for the portfolio with the biggest falls occurring at the beginning through to mid-quarter. Overall, equities lost ground over the course of the quarter, but it fixed income that witnessed the biggest overall falls. The alternatives sector managed to produce positive returns offsetting some of the downside for investors
Within equities, the star performer was the Fidelity Asia Pacific ex Japan fund in absolute returns whilst it was the Schroder Recovery fund that produced the strongest positive contribution to the portfolio. The main detractor for performance came through Japanese equities with the growth style bias of the JPM Japan fund struggling in the current environment. in addition, Emerging Markets and European funds negatively contributed, whilst the mid cap UK equity had a torrid quarter. Within fixed income, every holding produced a negative return, with the biggest negative contribution coming from the Barings EM Debt fund.
Fund Selection
We did not add or remove any funds this quarter.
CAUTIOUS - Portfolio Activity: Asset Allocation & Fund Selection
Asset Allocation
There were no changes in the asset allocation this quarter. Throughout the quarter we maintained our equity overweight position. We continued to hold our overweight position in European and Emerging Market equity markets, and we also retained our allocation to the UK large cap market. In fixed interest, we kept an underweight to bonds.
Portfolio Performance & Underlying Holdings
It was a negative quarter for the portfolio with the biggest falls occurring at the beginning through to mid-quarter. Overall, equities lost ground over the course of the quarter, but it fixed income that witnessed the biggest overall falls. The alternatives sector managed to produce positive returns offsetting some of the downside for investors
Within equities, the star performer was the Fidelity Asia Pacific ex Japan fund in absolute returns whilst it was the Schroder Recovery fund that produced the strongest positive contribution to the portfolio. The main detractor for performance came through Japanese equities with the growth style bias of the JPM Japan fund struggling in the current environment. In addition, Emerging Markets and European funds negatively contributed, whilst the mid cap UK equity had a torrid quarter. Within fixed income, every holding produced a negative return, with the biggest negative contribution coming from the Barings EM Debt fund.
Fund Selection
We did not add or remove any funds this quarter.
BALANCED - Portfolio Activity: Asset Allocation & Fund Selection
Asset Allocation
There were no changes in the asset allocation this quarter. Throughout the quarter we maintained our equity overweight position. We continued to hold our overweight position in European and Emerging Market equity markets, and we also retained our allocation to the UK large cap market. In fixed interest, we kept an underweight to bonds.
Portfolio Performance & Underlying Holdings
It was a negative quarter for the portfolio with the biggest falls occurring at the beginning through to mid-quarter. Overall, equities lost ground over the course of the quarter, but it fixed income that witnessed the biggest overall falls. The alternatives sector managed to produce positive returns offsetting some of the downside for investors
Within equities, the star performer was the Fidelity Asia Pacific ex Japan fund in absolute returns whilst it was the Schroder Recovery fund that produced the strongest positive contribution to the portfolio. The main detractor for performance came through Japanese equities with the growth style bias of the JPM Japan fund struggling in the current environment. In addition, Emerging Markets and European funds negatively contributed, whilst the mid cap UK equity had a torrid quarter. Within fixed income, every holding produced a negative return, with the biggest negative contribution coming from the Barings EM Debt fund.
Fund Selection
We did not add or remove any funds this quarter.
CAPITAL GROWTH - Portfolio Activity: Asset Allocation & Fund Selection
Asset Allocation
There were no changes in the asset allocation this quarter. Throughout the quarter we maintained our equity overweight position. We continued to hold our overweight position in European and Emerging Market equity markets, and we also retained our allocation to the UK large cap market. In fixed interest, we kept an underweight to bonds.
Portfolio Performance & Underlying Holdings
It was a negative quarter for the portfolio with the biggest falls occurring at the beginning through to mid-quarter. Overall, equities lost ground over the course of the quarter, but it fixed income that witnessed the biggest overall falls. The alternatives sector managed to produce positive returns offsetting some of the downside for investors
Within equities, the star performer was the Fidelity Asia Pacific ex Japan fund in absolute returns whilst it was the Schroder Recovery fund that produced the strongest positive contribution to the portfolio. The main detractor for performance came through Japanese equities with the growth style bias of the JPM Japan fund struggling in the current environment. In addition, Emerging Markets and European funds negatively contributed, whilst the mid cap UK equity had a torrid quarter. Within fixed income, every holding produced a negative return, with the biggest negative contribution coming from the Barings EM Debt fund.
Fund Selection
We did not add or remove any funds this quarter.
ADVENTUROUS - Portfolio Activity: Asset Allocation & Fund Selection
Asset Allocation
There were no changes in the asset allocation this quarter. Throughout the quarter we maintained our equity overweight position. We continued to hold our overweight position in European and Emerging Market equity markets, and we also retained our allocation to the UK large cap market. In fixed interest, we kept an underweight to bonds.
Portfolio Performance & Underlying Holdings
It was a negative quarter for the portfolio with the biggest falls occurring at the beginning through to mid-quarter. Overall, equities lost ground over the course of the quarter. The alternatives sector managed to produce positive returns offsetting some of the downside for investors
Within equities, the star performer was the Fidelity Asia Pacific ex Japan in absolute returns whilst it was the Schroder Recovery fund that produced the strongest positive contribution to the portfolio. The main detractor for performance came through Japanese equities with the growth style bias of the JPM Japan fund struggling in the current environment. In addition, Emerging Markets and European funds negatively contributed, whilst the mid cap UK equity had a torrid quarter.
Fund Selection
We did not add or remove any funds this quarter.
Putin’s attack on Ukraine changes 2022 market parameters
Against our expectations, Russia has launched a broad assault on Ukraine. Previous thinking was that Russia’s Putin would not dare an outright invasion of its neighbour in light of the likely cost of lives of Russian soldiers and economic hardship for Russian society at large.
Vladimir Putin’s decision of a large-scale invasion of Ukraine marks the end of 50 years of political understanding that large scale land war is no longer a political option in Europe’s political theatre. As such it will have marked a major paradigm shift of European politics towards Russia. The West has to accept that our dependency on fossil fuels has provided Russia the currency reserves and economic prowess that emboldened them to attack their neighbour and accept the risks of otherwise crippling global sanctions the war on a significant European neighbour brings.
As a consequence, Europe will not only want to end energy dependency on Russia but also cut them off from further funding for any more territorial expansion aspirations. More importantly, perhaps, Russian aggression will provide European policymakers with the public support necessary to significantly ramp up government debt-financed investment in the CO2 energy transition through regulatory change, cushioned by fiscal support. This leads us to expect a reversal of the waning prospect of continued fiscal support in the post-pandemic environment, especially in Europe. Indeed, a policy acceleration in this direction has the potential of providing a significant catalyst for growth over the next three to five years.
Turning to the more immediate impact of Russia’s hostile actions on capital markets it is worth noting that while significant, market action this year has arguably been driven more by the prospect of central banks’ monetary tightening agenda. This headwind is now likely to ease as the impact of the likely very significant package of western sanctions on Russia has the potential to slow growth prospects enough to quash any concerns of an overheating economy in the shorter term.
Nevertheless, the most notable impact of such sanctions for the broader public will inevitably be further price rises in the energy sector, with fuel prices at the pump quite conceivably moving from £1.5/l towards £1.75/l. Similarly, the prospect of receding heating prices towards the end of the year is looking increasingly less likely. For the US, the immediate energy impact is naturally likely to be lower. However, given the monocausal driver of price rises being energy shortages, rather than demand increases across a wide range of goods and services, we can also expect a different reaction function from central banks, again especially in Europe. A cost shock weighs on growth and so slows inflationary dynamics. Announcements to the effect of monetary policy flexibility returning are a reasonable expectation in response to a market liquidity shortfall first (as markets sell off for cash) and possible growth shock later.
It is important to note that today’s market shock is of an entirely different, and much less severe, nature compared to what we experienced two years ago with COVID-19. In 2020 markets came to realise that the pandemic would have an unprecedented, and entirely uncertain impact on the global economy. Russia’s war on Ukraine will have an impact on 2022 energy prices and trade with Russia which is far more limited and introducing less uncertainty in its potential impact on the global economy.
After two years of successfully mobilising every part of society to overcome a common enemy in the form of a virus, mobilising western resources towards fundamental change to face off the more familiar threat of a largely isolated Russia may prove far more achievable than before the pandemic precedent. As a result, there are likely to be aspects of this terrible humanitarian event having a more positive economic and market effect than it may feel at the moment.
How has this affected Tatton’s portfolios?
We have very limited exposure to Russia or Ukraine in our portfolios with none of them holding more than 1% and balanced portfolios in general holding around 0.5%. In more general terms our portfolios invest across different types of investments (assets) and geographic regions to benefit from diversification. However, as you would expect, portfolios with a greater allocation towards equities are most affected by sudden market movements. We review the relative weightings across portfolios every day and consider the latest market developments to continuously assess whether our positioning is appropriate.
With such unpredictability in the situation in Ukraine and the wider economic impact being more sector specific, in energy costs for example, we will not currently be making any immediate portfolio adjustments. We believe our current positioning is appropriate for the current environment. We want to keep our portfolios invested at levels that will allow them to participate and benefit fully when the extent of the conflict is more apparent.
While we continue to monitor our portfolios as a whole, we are constantly reviewing their individual component parts. It’s our job to ensure that the underlying funds that make up our portfolios perform as anticipated through the prevailing market environment. We expect our active managers to be taking advantage of the recent volatility in markets, but we want to ensure they remain committed to the philosophies for which we selected them in the first place.
What is Tatton doing to preserve the value of my investments?
In times of heightened levels of uncertainty just like when the pandemic first hit, everybody feels the collective instinct to ‘do something’ to try to take control of events. As investment managers, we face the same pressure to sell during times of volatility and war in Europe creates great humanitarian and economic concern. However, it’s our job to resist such pressure and to persist with our long-held investment beliefs. We know that holding well-diversified portfolios helps to cushion the impact of market falls, especially when compared against holding equities directly. We also know that it’s important to have our portfolios positioned in ways that will allow us to act swiftly and decisively when good buying opportunities present themselves.
Is now the right time to buy?
Market uncertainty and a fall in the valuation of stock markets can present buying opportunities. However, it’s worth remembering that we are still in the early stages of this conflict and its quite likely that there will be market volatility over the coming weeks. Markets are not behaving irrationally but there is considerable uncertainty as to how long and how widespread the conflict will be. As responsible guardians of your money, we still take the view that ‘timing the market’ is a high-risk gamble and that ‘time in the market’ is the best way to build long-term investment returns.
How can I keep up to date on my investments?
We will keep sending out portfolio statements as usual and will continue to send updates on market developments. All our market updates are available to view on our website. Your Financial Adviser and your investment platform will be able to provide you with daily valuations should you need them. If you have any questions at all about your investment, talk to your Financial Adviser first. They are familiar with your personal circumstances and will be best placed to discuss your investment with you.
Lothar Mentel
Chief Investment Office (TIM)
24th February 2022
DEFENSIVE - Portfolio Activity: Asset Allocation & Fund Selection
Asset Allocation
The portfolio was updated in October 2021. Throughout the quarter we maintained our equity overweight position. We took the decision to neutralise any drift and rebalance our position to 4% of the overall portfolio. We continued to hold our overweight position in European equity markets to benefit from strengthening demand in the region as supportive policies remained in place and global economic recovery continued. We reduced our cash exposure by 2% in favour of fixed interest investments
Within fixed interest we reduced our exposure to strategic bonds in favour of increasing exposure to government debt and emerging markets.
Portfolio Performance & Underlying Holdings
Equities and Alternatives were the drivers of returns whilst Fixed Income detracted. The Alternative sector was supported by both positive returns for the Atlantic House and Neuberger fund.
In regional equity markets the US was the strongest performer particularly large caps. Negative performance came from Emerging Markets and Japan.
Fund Selection
We removed exposure to the AQR Global Aggregate Bond fund. AQR Capital Management announced in November their decision and intention to close the fund, as they came to the business decision that this fund, amongst others within their fixed interest strategies (not held in Tatton portfolios), were no longer commercially viable for them. We replaced the fund with the HSBC Global Aggregate Bond Index fund. This fund tracks an Index that is very similar to the AQR Global Aggregate Bond fund strategy. We also took profits in the L&G Global Inflation Linked Bond fund and closed this position.
Summary of changes:
CAUTIOUS - Portfolio Activity: Asset Allocation & Fund Selection
Asset Allocation
The portfolio was updated in October 2021. Throughout the quarter we maintained our equity overweight position. We took the decision to neutralise any drift and rebalance our position to 4% of the overall portfolio. We continued to hold our overweight position in European equity markets to benefit from strengthening demand in the region as supportive policies remained in place and global economic recovery continued. We reduced our cash exposure by 1% in favour of fixed interest investments.
Within fixed interest we reduced our exposure to strategic bonds in favour of increasing exposure to government debt and emerging markets.
Portfolio Performance & Underlying Holdings
Equities and Alternatives were the drivers of returns whilst Fixed Income detracted. The Alternative sector was supported by both positive returns for the Atlantic House and Neuberger fund.
In regional equity markets the US was the strongest performer particularly large caps. Negative performance came from Emerging Markets and Japan.
Fund Selection
Over the quarter we changed our underlying European manager exposure removing the Barings Europe Select fund. This removed some of the mid and small cap bias we have held for clients in this region as this manager has struggled to keep pace with the returns we would have expected from the area of the market it is exposed to. We have replaced this fund with the JPM European Dynamic fund. We also removed exposure to the AQR Global Aggregate Bond fund. AQR Capital Management announced in November their decision and intention to close the fund, as they came to the business decision that this fund, amongst others within their fixed interest strategies (not held in Tatton portfolios), were no longer commercially viable for them. We replaced the fund with the HSBC Global Aggregate Bond Index fund. This fund tracks an Index that is very similar to the AQR Global Aggregate Bond fund strategy. Finally, we took profits in the L&G Global Inflation Linked Bond fund and closed this position.
Summary of changes:
BALANCED - Portfolio Activity: Asset Allocation & Fund Selection
Asset Allocation
The portfolio was updated in October 2021. Throughout the quarter we maintained our equity overweight position. We took the decision to neutralise any drift and rebalance our position to 4% of the overall portfolio. We continued to hold our overweight position in European equity markets to benefit from strengthening demand in the region as supportive policies remained in place and global economic recovery continued. We reduced our cash exposure by 1% in favour of fixed interest investments Within fixed interest we reduced our exposure to strategic bonds in favour of increasing exposure to government debt and emerging markets.
Portfolio Performance & Underlying Holdings
Equities and Alternatives were the drivers of returns whilst Fixed Income detracted. The Alternative sector was supported by both positive returns for the Atlantic House and Neuberger fund.
In regional equity markets the US was the strongest performer particularly large caps. Negative performance came from Emerging Markets and Japan.
Fund Selection
Over the quarter we changed our underlying European manager exposure removing the Barings Europe Select fund. This removed some of the mid and small cap bias we have held for clients in this region as this manager has struggled to keep pace with the returns we would have expected from the area of the market it is exposed to. We have replaced this fund with the JPM European Dynamic fund. We have also rotated some of our US large cap exposure into the Alliance Bernstein Concentrated US fund reducing our exposure to expensive mega cap stocks. We also removed exposure to the AQR Global Aggregate Bond fund. AQR Capital Management announced in November their decision and intention to close the fund, as they came to the business decision that this fund, amongst others within their fixed interest strategies (not held in Tatton portfolios), were no longer commercially viable for them. We replaced the fund with the HSBC Global Aggregate Bond Index fund. This fund tracks an Index that is very similar to the AQR Global Aggregate Bond fund strategy. Finally, we took profits in the L&G Global Inflation Linked Bond fund and closed this position.
Summary of changes:
CAPITAL GROWTH - Portfolio Activity: Asset Allocation & Fund Selection
Asset Allocation
The portfolio was updated in October 2021. Throughout the quarter we maintained our equity overweight position. We took the decision to neutralise any drift and rebalance our position to 4% of the overall portfolio. We continued to hold our overweight position in European equity markets to benefit from strengthening demand in the region as supportive policies remained in place and global economic recovery continued. We also retained our allocation to the UK large cap market, which was funded through a reduction in smaller cap stocks within the UK. Within fixed interest we reduced our exposure to strategic bonds in favour of increasing exposure to government debt and emerging markets.
Portfolio Performance & Underlying Holdings
Equities and Alternatives were the drivers of returns whilst Fixed Income detracted. The Alternative sector was supported by both positive returns for the Atlantic House and Neuberger fund. In regional equity markets the US was the strongest performer particularly large caps. Negative performance came from Emerging Markets and Japan.
Fund Selection
Over the quarter we changed our underlying European manager exposure removing the Barings Europe Select fund. This removed some of the mid and small cap bias we have held for clients in this region as this manager has struggled to keep pace with the returns we would have expected from the area of the market it is exposed to. We have replaced this fund with the JPM European Dynamic fund. We have also rotated some of our US large cap exposure into the Alliance Bernstein Concentrated US fund reducing our exposure to expensive mega cap stocks. We also removed exposure to the AQR Global Aggregate Bond fund. AQR Capital Management announced in November their decision and intention to close the fund, as they came to the business decision that this fund, amongst others within their fixed interest strategies (not held in Tatton portfolios), were no longer commercially viable for them. We replaced the fund with the HSBC Global Aggregate Bond Index fund. This fund tracks an Index that is very similar to the AQR Global Aggregate Bond fund strategy. Finally, we took profits in the L&G Global Inflation Linked Bond fund and closed this position.
Summary of changes:
ADVENTUROUS - Portfolio Activity: Asset Allocation & Fund Selection
Asset Allocation
The portfolio was updated in October 2021. Throughout the quarter we maintained our equity overweight position. We took the decision to neutralise any drift and rebalance our position to 4% of the overall portfolio. We continued to hold our overweight position in European equity markets to benefit from strengthening demand in the region as supportive policies remained in place and global economic recovery continued. We also retained our allocation to the UK large cap market which was funded through a reduction in smaller cap stocks within the UK.
Portfolio Performance & Underlying Holdings
Equities and Alternatives provided positive returns over the quarter. The Alternative sector was supported by both positive returns for the Atlantic House and Neuberger fund. In regional equity markets the US was the strongest performer particularly large caps. Negative performance came from Emerging Markets and Japan.
Fund Selection
Over the quarter we changed our underlying European manager exposure removing the Barings Europe Select fund. This removed some of the mid and small cap bias we have held for clients in this region as this manager has struggled to keep pace with the returns we would have expected from the area of the market it is exposed to. We have replaced this fund with the JPM European Dynamic fund. We have also rotated some of our US large cap exposure into the Alliance Bernstein Concentrated US fund reducing our exposure to expensive mega cap stocks.
Summary of changes:
It was almost a year ago when the markets began to wobble heralding the start of the downturn and the subsequent recovery we have been experiencing ever since. Although the losses of the March-April 2020 turned to swift recovery soon after, markets did not reach the pre-COVID 19 levels until the last few weeks of 2020. As a result, it is true to define last year as one of ‘lost’ opportunities as the markets spent most of it recovering the losses suffered in early spring; and only registering some gains towards the end. Some would argue that the recovery has been remarkably swift under the circumstances. They highlight the fact that in comparison, after the global financial crisis of 2008-09 (which was arguably less ‘costly’ than now), it took two and a half years of recovery before we returned to any pre-crash levels.
Although markets have wobbled somewhat recently, experts believe that the outlook for this year has been steadily improving, which has fed through to market expectations for further growth in the coming months. This, of course (and as always), is invariably dependent on several events occurring: a successful vaccination campaign, an early end to lockdown and swift economic recovery thereafter, to name but a few.
In addition to these, there are other factors which are likely to influence economic activity in general and investments in particular. One of these is inflation, which has already been addressed in the last update. If experts are proven right, as spending increases after lockdown there is danger that prices may rise as a result, something that has been restricted through inactivity during the lockdown period.
Another factor is taxation. All the generous financial support governments have afforded us during the last twelve months needs to be recouped at some stage. As there are limited options on how this can be achieved, many believe that more punitive taxation is on the horizon, to pay for high government debt accumulated so far; and which is likely to grow even further in the near future.
Politics will also a play a great part in this. The new government in the United States, for example, has already promised to support the economy “as long as it takes”. This means more borrowing, which is likely to lead to higher taxation, especially in the corporate sector. Whether we are in agreement politically with this action, the fact remains that less corporate profit could mean lower margins and therefore less investment; thereby, the equity markets could suffer as a result. On the other hand, this action could stimulate both public and private spending leading to greater demand and increased economic activity.
Either way, there are bound to be both winners and losers. The impact on our investments is simple. There has to be an even more selective approach as to which sectors and funds are capable of delivering results for our portfolios, in an ever increasing in complexity financial environment. It also means making the right selection on which fund managers we should use to make these decisions. Choosing the right fund manager is very important and we should be mindful that the ‘winners’ of the past might not be those who will deliver in the future.
This has already become apparent and evidence suggests that some of those who performed well in the past are not necessarily performing as well under the current environment. Therefore, the monitoring of investment activity and performance which has been one of the main drivers of sustainable growth, will become even more important in the future. Within our investment environment, this means that the right portfolio creation could make all the difference. Furthermore, this activity should take the form of constant monitoring and be flexible enough to accommodate swift changes.
In our case, we often use a discretionary fund manager (DFM) to achieve this. Discretionary investment management is a form of management in which investment decisions (and portfolio creation in general) are made by a portfolio manager on behalf of a client. The term ‘discretionary’ refers to the fact that investment decisions are made at the portfolio manager's discretion. However, guidance (on aspects such as attitude to risk and capacity for loss) and monitoring (on performance and continuous suitability) are carried out by the financial adviser on behalf of the client, who also chooses/recommends the suitable DFM. This offers a number of benefits to us as investors:
THE BUDGET
Since this commentary coincides with the annual Budget, I thought it will be a good idea to look at some aspects of it in more detail. As you are aware, on Wednesday the Chancellor of the Exchequer Rishi Sunak delivered this year’s Budget. All the media outlets have already highlighted the main elements of it and a great deal has been said about it since. I would like to take this opportunity to look at the main points announced and assess how they would impact us as investors:
As you can imagine, there has been a mixed reaction to this Budget. On the one hand there is relief that some of the punitive measures anticipated have not materialised and the financial support from the state “to those most in need” will continue for the foreseeable future, at least. Conversely, many are beginning to realise that we will be paying for the recovery over a long time and any incentives are only temporary to prevent a worse state of affairs. One commentator has likened it to a war situation – “last time this country faced such an event it took decades to pay back the debt accumulated by the state”. We all know that this means higher taxation to come sooner or later.
Experts believe that any long-term incentives/stimulus normally associated with economic recovery efforts (under normal circumstances) are not even under consideration at this stage and will not be so until we have a better idea how long this pandemic will last. However, there are many positive signs that there is more light at the end of the tunnel and the financial markets have proven that they are robust enough not only to withstand the impact we are experiencing but also be in a position to quickly recover and push on beyond the pre-Coronavirus performance levels.
It is hardly surprising that, once again, the last few weeks brought with them major changes worldwide. Rising infection rates in many parts of the world, political instability in the US (the largest economy in the world for now), uncertainties about what a Brexit deal (if any) would entail and China’s economic (and political) issues have contributed to this. The more optimistic amongst us felt that the mass vaccination, allied to the resolution of the presidential election issues in the USA would herald a more stable economic outlook. Add to this the last-minute agreement between Britain and the European Union, which was designed to remove the uncertainties of Brexit you could not help but feel more optimistic that the worst is now behind us. However, has this proved to be the case so far?
Stock markets appeared happy enough and continued to rise, providing one of the most positive receptions of a presidential inauguration in history. While pleasing for investors – ours included – it is increasingly putting markets out of alignment with the most optimistic of assumptions. As we have noted before, current market valuation levels are deemed ‘rationally exuberant’ under the current (and obvious to all) circumstances. As corporate earnings (how much money a company or corporation has made during a certain period of time) are anticipated to recover when pent up demand catapults the world economy back to above the previous rate of growth, valuation levels should normalise, while potentially providing further market improvements should the recovery prove stronger than anticipated. In this case, market ‘valuation’ is the process used by financial market participants to determine the price they are willing to pay or receive to ‘effect’ a sale of a business. Similarly, these valuations have an impact on the price of shares and ultimately investment performance. Unfortunately, this also assumes central banks will keep interest rates and other lending methods supressed, even if economic activity roars back to life – a scenario at odds with itself.
These assumptions make investment markets vulnerable to setbacks, due either to future corporate earnings growth or changes to interest earned from other investments (or lending), with or without further central bank action. It is true that central banks have stated they are willing to tolerate a temporary inflation rate increases above their original targets, but the question is by how much and for how long; or rather, whether investment markets are assuming/anticipating higher levels of growth than central banks may deem acceptable if they want to remain aligned with their longer-term monetary targets of maintaining long term economic stability.
That being true, people’s experience is that excessive government spending fuelled by central banks buying up ‘debt’ eventually leads to runaway inflation (decrease in the purchasing power of money, reflected in a general increase in the prices of goods and services), which undermines monetary stability and in its wake the economy and prosperity. ‘Debt’ in this case mostly consists of what a government would borrow to finance its spending through the issue of ‘bonds’; and which can be bought back, if so required. While this observation has historical merit, it is not quite that simple. Put simply, if there is more demand which is also backed up by more money at hand than there is supply, then prices will be forced up. However, such price pushes only turn into inflation (sustained periods of rising prices) if wage earnings can compensate for such rises. Economists currently neither expect that there will be a sustained lack of supply of goods and services, nor do they anticipate wage earners will have a strong enough a negotiating position to realise inflation-beating pay rises, while there is also mass unemployment.
In reality, experts believe that it is unlikely that we will experience world economies bouncing back within the shortest of time periods, from the worst recession on record, to the biggest ever economic boom. They also believe that it is inconceivable that mass unemployment will turn to wage-increasing labour shortage. That being the case, they feel that this is not a particularly realistic expectation and so it is probable that low levels of unemployment do not lead to galloping wage inflation; as has been the case prior to the pandemic. However, this does not mean inflation will never rear its ugly head again, but they do believe that it is far more likely to be an issue further into the future.
Overall, even in the absence of actual inflation, experts believe that the mere fear of it could become a risk to 2021’s investment markets, which have grown dependent on low interest rates, while also requiring forthcoming above-average economic growth. They remain positive about the prospects for the global economy, but at the same time retain their “professional wariness” which has them monitor the economic and capital/investment market developments very closely, as they “steer investment portfolios though these uncharted waters”. There is little doubt that the bigger challenge this year is the rollout of vaccines to tackle the global pandemic. Is the speed of distribution and uptake of the jab enough to keep the economy afloat in 2021 or will it burst and come crashing down to earth? The view of most experts is that only time will tell, which makes future uncertainty especially in the shortterm an inevitable reality.
On a more positive note, and despite the upheaval of the past year, in investment terms we have started 2021 in much the same position we were 12 months ago – before the pandemic. The extraordinary support provided by central banks has kept the global financial system awash with liquidity. Investment markets worldwide, especially in the US, are trading at all-time highs, while major equity (stocks and shares) indices all over the world have rallied to their highest levels in months. Market moves have been driven not by current economic reality, but by economic expectations and the promise that strong growth is just around the corner. However, there is also the danger that this share price exuberance is giving some investment managers concern that markets have become too expensive and fearing that – sooner or later – reality will have to set in. This is why, as you have probably noticed from recent activity in your portfolios, they have begun to take measures in order to reduce the risk of another fall in the markets. Although this is dependent on what happens worldwide (and perhaps some of it outside of anyone’s control), they could at least reduce most of the risks that they can control.
For many of us, who monitor our investments on a regular basis, we could not help but notice that the fund managers have made considerably more changes to our portfolios in the last ten months than ever before. If January is an indicator of any future trend, this is likely to continue for some time to come. This is not solely a by-product of recent events, rather an indication of a potentially future intend and intent! Investment managers have come to realise that we are now entering a new era and that the benign investment environment we have all experienced in the last decade is truly over. For some experts, recent events should serve as a timely reminder of what could happen if complacency sets in, as market expectations had been conditioned by the same premise – that any economic recession can always be fixed by the same remedies used in the past.
For us, this should be seen as a positive move and one that should hopefully herald a new era of unlimited potential. Observers believe that this recovery has been driven by a different and new catalyst. In order to drive recovery and diversify from certain sectors, investment managers looked at alternative solutions for this recovery. Out went the usual investment components such as travel, entertainment, aerospace, and hydrocarbon related industries, which were often the mainstay of portfolio creation. At the same time, investors turned to assets which in the past were marginalised and were only included in a portfolio to make people feel better that something is being done to save the planet. Investments in alternative energy, sustainable resources, next generation information technology and electric cars are now becoming an increasing proportion of assets used in a portfolio creation. This does not mean that some of the usual suspects are ignored. Observers believe that there is still potential in companies such as Amazon, Google and Apple. However, they believe that there is also investment potential elsewhere and these are no longer the only ‘growth generators’ of note.
This has been a contentious issue in the last year, with people on both sides of the argument providing evidence to support their theories. On the one hand, there are those who still believe that the sectors and companies (such as pharmaceuticals) who have helped us out of the economic mire experienced recently, are now in a better position to catapult the world economy to the next level, as they have come out of it much stronger and with deeper pockets. On the other hand, there are those who believe that the economic future lies elsewhere. The middle ground (and where most of the consensus lies) is that you can achieve a more robust, sustainable and flexible investment approach from a blend of both ‘old’ and ‘new’. The most prevalent feedback from the fund managers in our sector is that any sustainable investor portfolio of the future will look a great deal different than what we have been used to in the recent past.
Each financial crisis in the last half century has been different than any before and brought with it a set of new and unique challenges. The markets, sooner or later, have always managed to overcome these challenges and as a result became more resilient. This time is no different, albeit much more severe, which would undoubtedly lead to new lessons being learned; and this is already apparent. Although there are (and have already been) casualties of this pandemic, the investment performance of recent months (and the swift recovery in investment terms) goes to show that (so far at least) the financial sector has the ability and resilience to deliver sustainable results long term. However, our recent history has also shown us that the investment sector should not be resting on its laurels.
After yet more turbulent weeks since our last communication, we thought it was time for another investment commentary before we go through the next hurdle of the changes anticipated from Brexit. This communication has taken a bit longer to be sent than the previous ones, primarily due to events on the other side of the Atlantic and all the uncertainties brought about by the presidential election; which interestingly took place nearly a month ago!
During a period when global stock markets continued their gradual upwards trend, which (against many expectations) saw November becoming one of the most productive in stock market history, government activity continues worldwide. Their objectives for now are twofold – control the spread of the virus until a suitable vaccine is found and getting the economy moving again before further damage is caused.
For the UK, it seems that the uncertainty is here to stay for a while longer even when the official lockdown ends this week, with the vast majority of England under tighter restrictions than before – and for an indefinite period of time. The Chancellor of the Exchequer Rishi Sunak’s stark warning that the UK’s “economic emergency has only just begun”, adding that debt-financed pandemic spending is “clearly unsustainable”. His downbeat tone was backed up by a report from the Office for Budget Responsibility (OBR), which forecasted a £30 billion hole in public finances by the middle of the decade. As well as plunging Britain into its deepest recession in over 300 years (although perhaps also the shortest!), government borrowing is set to rise to its highest level in peacetime. In typical belt-tightening fashion, the Chancellor added: “We have a responsibility, once the economy recovers, to return to a sustainable fiscal position.” There is no indication from any government representative as to when “recovery” is anticipated, which is not surprising under the circumstances.
This hints at tax rises or spending cuts over the medium and long-term, but Sunak made no comment on which of these he would prefer. The Institute for Fiscal Studies (IFS) nonetheless took the November outlook at its word and is predicting more than a £10 billion a year cut to departmental spending plans from next year and beyond. The IFS is also assuming that emergency pandemic spending will end next year, as well as the temporary increase in Universal Credit. This action would also be dependent on what happens with Brexit. We discuss Brexit developments in the past but, needless to say, if no deal with our largest trading partner is forthcoming, the UK’s fiscal and economic outlook will be considerably worse and this will be reflected in a potential revision of these figures.
Talking of Brexit, in the strangest year in recent memory, one news story serves as a timeless constant: “Brexit talks remain deadlocked”, according to the FT’s headline recently. Ironically, this could have been from any point in the last four and a half years. European leaders have been quick to comment that it was still impossible to predict whether Brussels could reach a trade deal with the UK. With Britain’s transition agreement with the European Union (EU) set to end on 1 January, reports suggest growing frustration in Brussels; and the negotiators who are directly involved, in particular. As one commentator puts it: “Having sailed past deadlines, crunch talks and other ‘last gasp’ moments, negotiations are now deep into extra time. Boris Johnson suspended talks last month after his self-imposed mid-October deadline passed, accusing the EU of not being serious enough. The Prime Minister wants a “fundamental” shift on the European side, but even conciliatory figures like Chancellor Angela Merkel are resolute that the EU will not sacrifice principles and interests.”
Even so, the FTSE 100 has remained calm in the last few weeks, especially after the vaccine news from Pfizer-Biontech and is still trading near the top of its post-pandemic range. The value of sterling, meanwhile, has increased through the month – even against the value of the Euro. Markets seem unphased by the uncertainty. In large part, this is because investors do not believe – even as we “race toward the cliff edge” – that a no-deal Brexit is possible. Exiting the EU empty-handed after more than four years of negotiations would be – in the Prime Minister’s own words – “a massive failure of statecraft”.
Brexit exempt, the rest of the world faces the same COVID-19 dilemma with similar outcomes. With swathes of the population still unable to go about their business as usual, cutting off support would choke any semblance of a recovery, and undermine compliance with COVID-19 restrictions worldwide out of sheer necessity to survive. Governments will no doubt be aware of this, which begs the question: What next if this pandemic continues well into next year?
Many of the governments are considering winding down the support policies as they are running out of funds to sustain them. However, as it is the case with Rishi Sunak’s attempts in the UK, unlike what has been suggested, these actions are neither ideological nor purely indecisive, but tactically political. With the crisis dragging on, political leaders must toe a fine line. On the one hand, they must convince the population they will offer unlimited support through the pandemic. On the other, they must convince capital markets and the money-trusting public that their treasuries are not running a money-printing scheme – or at least not one any bigger than comparable nations. If it fails on the first count, confidence will plummet, unemployment will spike and a full-blown ‘classical’ recession will ensue. If it fails on the second, it risks undermining confidence in its currency value – leading to financial instability which leads to a similar outcome. Perhaps this may explain why they are finding it difficult to strike a balance, not least in the UK.
The first risk is most certainly the more pressing. As such, experts expect governments will borrow, the central banks will buy debt in similar proportions with money only they can create, and we can all just keep our fingers crossed that the recovery strategy works; and that our economic growth can outgrow the risen debt and burden it may bring much further down the line. In the meantime, government hints at fiscal restraint need to be seen as an expectation setting tool more than forward guidance. It will be interesting to see what the new US administration plans to do in the coming months, in view of the headwinds they are facing: rising infection rates, higher unemployment and a potential intransigence from the Senate which may well end up with a Republican majority in January. Ironically, despite the political upheaval experienced recently the US markets continue to surge. As we speak, the Dow Jones is now performing at higher levels than before the pandemic began and shows no signs of abating. The view from the experts is that it has a great deal to do with being so close to having a vaccine able to provide at least a meaningful protection against COVID-19.
In Europe, despite political obstacles to the recovery plan (and some public resistance to it), fiscal expenditure is increasing. With the German government agreeing more emergency aid to businesses and increased vaccine spending, the support will likely spill over to the rest of Europe (and the world). European fiscal spending is backed by substantial support from the European Central Bank (ECB). It is a peculiar turn of events that leaves Europe – usually the fiscal miser of the developed world – as the most promising area in terms of government support spending. Experts believe that both US and UK governments would do well to take note – with the world still under heavy restrictions amid the deepest recession on record, a decisive and sustained economic recovery, not a balanced budget should be the focus of governments.
Meanwhile, there are indications from recent economic data that China is in full economic recovery mode. Yet, this has led to a classic situation for markets. Having anticipated the growth, markets are facing the possibility that China’s policy reactions may now be starting to work against more growth in the markets, and stocks in particular.
Yet again, the undercurrent of this commentary is one of even more unsettling news. However, for those of us closely looking at the performance of our investment portfolios, would note that almost all of the losses incurred during the earlier parts of this year have now been recovered; reflecting what has been occurring in the wider investment markets. Therefore, the question still remains whether the market sentiment does realistically reflect the reality of the economic environment. Recent experience tells us that the longer we navigate through the unusual times we currently live in, the greater the unpredictability of the performance we see in investments, which seems to contradict many of the fundamental indicators of investment behaviour.
However, the last thing investment managers should be doing right now is to become complacent, expecting that this trend would continue. This is the time of the year when traditionally ‘profit taking’ tends to occur, particularly since we have had a very productive November. Profit-taking is the act of selling assets (such as shares) in order to lock in gains after it has risen appreciably. While this process benefits the investor taking the profits, it can hurt other investors by sending assets of their investment lower, without notice. It can affect an individual stock, a specific sector, or the broad financial market. If there is an unexpected decline in a stock or equity index (for example) that has been rising, with no news or external events to support a selloff, it may be attributed to many investors taking profits. Ultimately, markets would fall leading to investment losses. This has occurred a number of times in the recent past and there is very little that the markets/wider system can do to prevent it.
On the positive side, our portfolios are actively managed by investment managers who are aware of this and should thus take action to prevent it; or at least limit the impact of it, in cases where the portfolio is predominantly investing in equites. Investors at large have been somewhat forgiving with investment managers in recent months as they understood that the unfolding events could not have been predicted and few (if any) investment managers could have foreseen the impact of and the havoc brought by COVID-19 worldwide. In their defence, seeing where we have achieved to date, most of them have managed to cope with the ensuing impact and have learned from it as a result. I doubt whether we can be as forgiving next time, if these lessons have not led to provisions designed to combat against such an event occurring again.
As this is our last commentary before Christmas, I would like to take this opportunity on behalf of DSN Financial Limited to thank you for your continuous support; and wish you a happy Festive Season. Let us hope that 2021 turns out to be a much kinder year to us all.
Merry Christmas.
After such a strong recovery in the investment markets during the second quarter of the year, it was perhaps somewhat inevitable that the summer months would be characterised by a period of general consolidation. It has been good not to lose ground in recent months, but making further headway has also been quite hard, particularly since so many varying scenarios, with different market implications, have remained on the table. For much of the past quarter the US markets have, once again, delivered some of the better returns, driven higher by the continued appetite for stocks (and shares) in the safe haven of the big technology heavyweights.
The UK markets, in contrast, have largely trod water with the mood being dampened by a combination of bleak economic data and greater awareness that the end of Brexit transition period is looming; and a trade deal has yet to be done. Coming to terms with uncertainty and managing expectations is not going to be easy for anyone.
The coronavirus has understandably been central to everything of late, but financial markets do now appear to be coming to terms with the prospect of having to live with the uncertainty of the pandemic, and its economic consequences, for an extended period. That has at least created a modicum of stability in recent months. In many ways this stability has been both helpful and welcomed after the frenetic volatility of the first half of the year, allowing for more sensible assessments to be made of where headwinds and tailwinds are likely to emanate from going forward and when. It is still far from clear what shape the recovery will take, but it has at least been encouraging to observe (particularly around mid-summer) a strong recovery in some leading economic indicators in both the manufacturing and services parts of many economies.
Headwinds in an economic situation represent events or conditions such as a credit crisis, that slow down the growth of an economy; so, headwinds represent something negative. Tailwinds, on the other hand, are the opposite and help to increase growth of an economy.
These indicators do, however, now show some signs of plateauing. The undercurrent of an escalation in COVID-19 cases around the world is understandably causing feet to hover nervously over brake pedals again, but there is some reasonable justification for believing that second-wave effects will not be as devastating on lives and the world economy as the first wave; particularly since we do now seem in a better position to manage the virus. We are also, hopefully, a little closer than we were to finding a vaccine solution. Whilst acknowledging that economic forecasting is still prone to greater error than usual, everything does suggest that recovery expectations for the remainder of the year and into next should be toned down and the chances of a global recovery to pre-COVID levels of economic output are still quite some way off.
But this does not necessarily mean that investment opportunities are drying up. On the contrary, as one expert put it: “continued levels of central bank stimulus, low interest rates and subdued inflation continue to sugar-coat a variety of investments”. Taking a balanced and active approach against a backdrop of uncertain economic data and likelihood of a resurgence of coronavirus taking hold over the winter months, balanced with all the positives stemming from continued stimulus, reliance on equities as part of a varied portfolio does still seem a sensible approach.
As mentioned earlier, there are both headwinds and tailwinds looming in the horizon. In the case of the former, political events in the US add to the uncertainty and this is likely to continue beyond election day, as votes would continue to be counted a while longer. The UK’s domestic perspective is not much less unnerving, with public divisions over the most appropriate reaction to the second COVID-19 wave growing by the day, while economic pressures are doubled up by the seemingly never diminishing uncertainties over a ‘deal-or-no-deal’ Brexit. If there is one thing both investment managers and investors at large dislike, it is uncertainty, which we have in abundance.
What of the tailwinds? On balance, from their feedback, investment managers can see improvements in what will drive economic and market fortunes beyond the immediate short-term time horizon. The noises coming from Westminster that negotiation progress with the European Union (EU) is being made, reconcile with observations that both sides have an even bigger economic interest in reaching amicable economic divorce terms than before, given the imperative of swift economic recoveries on both sides. Furthermore, because of the UK’s regrettable underperformance – both in terms of public health and economic damage sustained from the epidemic – there should be less appetite from the UK government to risk a crash Brexit scenario; or this is what the markets are hoping for certainly in the short-term at least, so they can react accordingly.
Similarly, for the US, an increasing number of market strategists are beginning to update their economic outlooks and view both presidential candidates with a more positive light. They feel that both Republicans and Democrats alike are proposing economic solutions which have the potential of stimulating recovery. Economic growth – rather than return of decline – is therefore increasingly what experts expect as the most likely scenario for 2021, assuming no new surprises occur in the meantime.
With continued substantial fiscal support from governments around the world coming into sync with central banks’ monetary support policy measures, the argument that the so-called ‘reflation trade’ will lead the world back to economic expansion (and thereby improving corporate earnings) is gaining validity. Reflation (trade) is the act of stimulating the economy by increasing the money supply or by reducing taxes, seeking to bring the economy (specifically price levels) back up to the long-term trend, following a dip in the business cycle. If the US is able to change political direction, and regains its former status as the world’s preeminent growth engine, this will increase the possibility of a meaningful upswing in the global trade cycle – overcoming the weakness in demand that characterised and marred the decade that followed the financial crisis.
This may sound like a very ambitious scenario for the investment markets and to a certain extent it is. However, investors must not forget that much of the effectiveness of recent monetary policy has been to bring forward future capital return potential from high-yielding assets (stocks and shares, for example) by suppressing the returns/’yield’ of the secure alternative investment, such as government gilts (fixed-interest loan securities issued by the UK government). While it is entirely reasonable to expect an economic rebound would prompt a further upward movement in share prices and thus investment returns, the really substantial moves are more likely to be found when investors begin to rotate their interest from the darlings of the low growth past (interest rate deposit driven savings that profited most from higher interest rates), to those that benefit from the more volatile longer term investments.
Against all expectations and despite considerable volatility (still), September turned out to be decidedly dull for investors. After a five-month rally had left global share prices around or above their pre-pandemic highs, the turn of autumn sent a chill through capital markets. Selling pressure built up early in the month, as COVID cases spiked around the world once more. The fear was that we were in for a repeat of March, where the spread of the virus and ensuing global economic shutdown sent markets into a panicked frenzy. But this time, level heads prevailed. Perhaps, at last we are beginning to learn from the lessons of six months ago. However, looking at the markets worldwide, the volatility has not gone away, nor is it showing signs of doing so. It is not unusual to still experience fluctuations in daily values of considerable amount and which in the past would have taken weeks to generate.
Volatility goes hand in hand with the ‘wait and see’ narrative coming through in investment markets and is not restricted to equities only. The hopes of a swift V-shaped (‘quick’) economic recovery that drove markets over the summer have been dashed by second wave fears, diminishing fiscal support from governments and a generally slowing rebound. The jury is still out on how long lockdown restrictions will need to last, and how quickly a vaccine – which would save lives rather than restrict social activities - can be produced and rolled out at scale.
If a vaccine which protects those most at risk can be achieved before the end of the year, or if the public health risks from the ‘second wave’ are not as great as what we saw during the first bout of COVID (which the experiences of Spain and France suggest), we should expect the economic recovery to resume. Even in that case, activity is unlikely to rebound as quick as we might hope. As one expert put it: “this goes hand-in-hand with reluctance of the more fearful to return to their former lifestyles not necessarily outweighed by gushing spending and activity increases by the demob happy young and fearless.”
That realistic outlook makes the second prong of the recovery policy all the more important. With consumers and businesses struggling to survive, central bank and government support has been vital. Central bankers have seemingly now committed to doing their part: keeping rates low and liquidity flowing for the long haul. But the fiscal side has recently left a little to be desired. Support is being handed out with less zeal than earlier in the crisis, and in some cases not handed out at all, which could drastically slow the recovery. This week alone, government ministers in the UK have warned that there is a limit to “government handouts”.
Unfortunately, the longer restrictions must remain in place, the more opportunity there is for a policy error. The biggest danger of this is in the US – where bitter political divisions seem to be hampering the progress of getting fiscal support to those who need it. We can take some comfort in the fact that both presidential candidates are likely to give some level of fiscal stimulus, but it is needed sooner rather than later. If none are forthcoming, there is a real danger that this forced recession could turn into a ‘classic’ downturn – driven by widespread corporate defaults and rising unemployment.
So, what does this mean for us, the investors? Based on the above assumptions, the initial view from the experts is more of the same as experienced in recent months – volatility borne from the uncertainty and an element of caution due to the forthcoming political events. The stock markets are still behaving differently to expectations, as many have already recovered from the losses experienced in the early days of the pandemic. Some of the reasons for this behaviour have been explained in my previous commentaries and they are the same today as then.
Direct investors in those markets (as well as their ‘agents’) have profit in mind, rather than the wellbeing of the economy or long-term investors like us. Therefore, faced with the recent growths we have been experiencing and the potential headwinds that we may face in the near future, their reaction is to ‘profit take’ whilst able to do so. Whilst in the past they would hold their nerve for the potential of longer-term gains, recent evidence suggests that it is no longer the case and this may explain the unusually big daily fluctuations experienced by markets around the world. Afterall, their motivation is not necessarily the same as that of governments and individuals with a long-term investment perspective.
Unlike the stock markets trading in individual stocks and shares, our investments are known as ‘collective/pooled’ investments. These are funds whereby our money is invested alongside other investors in order to benefit from the inherent advantages of working as part of a group. This is carried out by a financial institution which groups assets from individuals and organisations to develop a single larger, diversified portfolio. A fund spreads its investment across different companies, asset types and geographical regions, giving us the benefit known as ‘diversification’. When one investment is down, another might be up, and you are not taking a chance on the fortunes of one single asset. This means your risk overall is significantly lessened, and by pooling money with other investors your buying power and access to assets and markets is greater than if you were buying single assets on your own. However, investors should be aware that diversification and multi-asset allocation do not fully protect against all market risk.
As far as the investment managers entrusted with peoples’ investments are concerned, their objectives are somewhat different to stockbrokers and much similar to collectives. Depending on the risk tolerance that an investor places on their portfolio, their job is to achieve the outcome expected from them, which in the case of most of us is to remove as much of the uncertainty created by these markets. How well they carry out that remit will determine whether they are suitable candidates to invest our funds. From our experience, it is becoming more evident that not every manager has managed to achieve this, which brings into question their suitability of helping us achieve our objectives.
One way of removing unsuitable investment managers is through ‘managed portfolio’ solutions, overseen by discretionary investment managers, whereby the portfolio has collectively a large number of these managers (and collectives) within it, none of whom has a proportion large enough to impact on the overall portfolio, if they fail to deliver. This has the impact of further spreading the risk (and volatility) across a number of these collective funds and expands the access to a number of assets into which we may choose to invest. Added to this is the ability of adding and removing investment funds at any time by the overall discretionary manager, in order to eliminate any long-term negative impact on the portfolio.
Discretionary investment management is based on the principle whereby the buy and sell decisions are made by portfolio managers on our behalf. The term ‘discretionary’ refers to the fact that investment decisions are made at the portfolio manager's discretion. This means that the manager is given permission by the investor to make swift decisions based on his/her own discretion. As they are experts in this field, discretionary fund managers are able to create portfolios by using a large number of other managed funds, specialising in different areas and sectors. One advantage of discretionary management is the ability to act quickly in order to take advantage of market conditions or, conversely, make adjustments to prevent any impact at times of adverse conditions. They are also able to run portfolios with a large number of funds within them, something that individuals may not be able to cope with. Their ability to retain our investments within each individual’s risk profile at all times, is also an advantage.
Most of us do use some kind of discretionary fund management within our portfolios, which would have had a positive impact in view of the events of the last six months. However, this does not mean that every discretionary manager performs the same, or their portfolio is suitable for everyone. Therefore, we need to exercise due care and attention in making the right choice. On their part, they have to be aware that if their performance does not match our expectations, we will be looking elsewhere for more suitable candidates. To this end, not only do we monitor their performance but also make sure that there is always an alternative solution. It is now more important than ever that investment returns are constantly monitored for the reasons already mentioned. In doing so, investment performance is based on prudent and active management, rather than the decision of a small number of people in the stock markets around the world and whose motivation may not be represented by our individual objectives.
In a week where the American presidential candidates have kicked off the next stage of their election campaign in earnest, investors have also noticed that there is a shift in the global investment markets. On the one hand, US equities continue to push at all-time highs, having recovered everything lost in March’s frantic sell-off – and then some. If the stock market soaring to new heights while the world languishes in its deepest ever recession is not staggering enough, we also note the US is accelerating away from its global peers.
On the other hand, while North American markets have gained substantially since their March lows, equities elsewhere (and the UK’s FTSE 100 in particular) have barely moved recently – seemingly locked around the same levels for the last few weeks. Granted, there have been substantial gains in these markets too, certainly since the lows of late March early April, but not at the same levels as experienced in the US. Whilst European and most other markets (for that matter) look similar, US and global investors have all given the world’s largest economy an overwhelming vote of confidence, for now!
In particular, investors are increasingly confident about America’s big tech superstars, with this sector emerging as an undisputed pandemic winner; with Apple and Amazon flexing their muscles even more, as competition heats up. This market optimism continues to be backed up by an abundance of liquidity. In addition, reports from the US Federal Reserve (Fed) have had an influence in recent developments. Primarily, the Fed from here on will allow inflation to rise above the stipulated 2% target for short periods of time. The announcement changes nothing right now, with the Fed holding interest rates at near-zero and pumping huge amounts of capital into the financial system. However, the message is clear as it does confirm what investors have suspected for some time: easy monetary policy is here to stay, even when the economy starts to recover.
The other part of the Fed’s dual mandate is to ensure full employment. However, historical evidence has prompted experts to maintain that fighting inflation almost always came ahead of bolstering employment. This has been as much a political as a monetary/fiscal approach. They believe that the Fed’s behaviour recently suggests it wants to go for full employment first and inflation containment later. With the new policy framework, the Fed is telling us it is in ‘easy’ mode for the long haul! As such, this could be an important turning point for monetary policy. Given the deep global recession we are in, a more flexible Fed does not mean that the dollar will weaken tomorrow, but it does make the Fed the most flexible and accommodative central bank in the world right now – which experts believe should lead to a weaker dollar in the long run. It is also clearly a ‘positive’ for the US as a whole, which might justify the investors’ American optimism.
As you may have noticed throughout my communications, a great deal of emphasis has always been placed on events in the United States. This is because of the size of the market and the individual dominance it has in the world investment domain, even compared to the collective influence of the European Union. Therefore, what happens in the next few weeks leading up to the presidential election will have a major impact on the world economy, far beyond that of politics alone.
Closer to home, UK markets over the last week have matched the weather, both unpredictable and indifferent. Clearly, the next stage of our economic recovery depends on getting people back to work. There are no real signs that this is imminent, but the return to schools in early September is a key part of that. Unfortunately, it is almost certain that increased opening measures – especially the reopening of schools – will cause at least some boost in virus cases. Whether this affects economic or market expectations depends on how big a spike we see and, crucially, how deadly that increased case load turns out to be. This we cannot know until at least a few weeks into September and even October. I would suspect that this uncertainty will continue even further in the weeks leading up to Christmas when we start spending more time indoors, which may lead to another spike. Regardless, this uncertainty is not going to go away any time soon.
It is hoped that the markets and investment managers have already factored this into their planning and, thus, another early spring (major) downturn can be avoided. Concerns for anther ‘spike’ is not the only major aspect occupying our thoughts, as Brexit is only some weeks away. Irrespective of your views on whether we should leave or remain in the EU, few will dispute that our departure from the ‘union’ comes with a great deal of uncertainty; not least because of recent events throwing in to doubt any seamless transition.
Earlier this year, faced with a plethora of news pointing to an uncertain future for the investment markets, we can be forgiven if we became concerned about our portfolios. Human nature is such that we tend to behave out of character when confronted with unexpected events. I am sure many investors have ‘encashed’ their investments at the wrong time, most likely in March and April this year when the markets were at their lowest. And who can blame them under the circumstances, when facing one of the worst financial collapses in history and the uncertainty of whether recovery is ever going to occur. A few months later and we are in a different situation, with the recovery almost complete, but who would have anticipated this a few months ago? Hindsight is a great thing after the event.
So where does this leave us now? Given that we are in a different position now compared to the start of the covid-19 era, should we be more optimistic? Based on the observations earlier in this commentary, it depends on your specific point of view. On the one hand, it could be argued that markets (and of course the investment managers) have learned from the events of earlier this year and have made adjustment to accommodate the new norm. The lessons learned would make investment managers more resilient (and better prepared) when markets misbehave again. Furthermore, positive action proactively should have been taken in order to comfort any future downturns. Afterall, last time no one would have foreseen what had unravelled before us, but lessons should have been learned as a result.
On the other hand, the argument is that the uncertainty is still there and there is no indication that we are through the worst, as far as the pandemic is concerned. This in turn would have an impact on the economic activity worldwide. Add this to Brexit concerns and the uncertainty of who will win the US presidential election and market volatility is likely to remain, certainly in the near future. One thing is certain – what we are going through right now is not going to go away any time soon. It is how we confront it that would make the difference. I would also like to add at this point that the markets themselves (and those involved within them) have contributed to this volatility. The search for profit above all, could sometimes lead to unusual (and unexpected) activity in the markets adding to unpredictability.
This means that navigating through the current investment minefield is even more difficult than ever before. However, the fact that investment managers we have entrusted with our funds have shown such resilience in recent months is a major positive. Not only did they manage to control the major downturn, but they were also able to make the changes required that has led to the recovery we have been experiencing since then. I have no doubt that there will be other market falls throughout the lifetime of our investments. I can testify to this, having gone through a few of these in my 34-year career in this industry.
Few would dispute that a fall is always followed by an even bigger recovery in time, with the markets even more resilient that the time before. This recovery may take a while longer sometimes, but lessons are always learned. Perhaps this may explain the reason for the swift recovery we are currently experiencing. The key is to show patience and appreciate the fact that both falls and recoveries in our investments would invariably occur throughout this process. These fluctuations are not suitable for every investor, which means that we need to assess our individual requirements and invest accordingly. Our attitude to risk, capacity for loss, term over which to invest, how (and when) funds are accessed, the costs of doing so and the associated tax implications are a few of the factors which need to be considered.
In order to achieve and optimise these factors we enhance our proposition by utilising the expertise of discretionary fund managers. This comes with solutions which are designed to reduce risk and enhance performance by providing the portfolios we have deemed to be the most suitable. This helps us navigate through the complexities of sophisticated investments, which are required to optimise performance and returns. It is they who will ultimately address the issues mentioned earlier, provide consistent returns and control the portfolio to prevent major falls. In doing so, we can be assured that we are getting the best outcome for our investment portfolios. As I mentioned before, if our investment managers of choice fail to do so, there will be no hesitation (from my part at least) in replacing them with others who can deliver a better outcome.
It has been a while since the last update, primarily because little has changed in market sentiment in the last few weeks. In fact, compared to the rest of 2020, July proved almost uneventful as global capital markets consolidated strong gains made during the previous quarter, with only emerging market equities and gold delivering notable advancements. Now, as August starts with stifling temperatures, thoughts can turn to the weeks ahead, which promise to be a bit different than what has been occurring recently, not least as we enter the ‘holiday season’.
August capital markets can be either quiet or decidedly choppy. As investors go on their summer holidays, daily trade volumes decline and liquidity drops out of the market – meaning even small buying or selling pressures can have outsized effects. Of course, this year we doubt many traders will be planning an August trip anywhere other than staying close to home. It is a common belief that overall market liquidity should not be an issue, all things being equal. Thanks to extraordinary interventions from central banks, capital markets are reasonably liquid meaning that fund availability (in the form of cash and easily available finance) is still prevalent; for now. And for equities/stocks and shares over the last few months, the rising prices have turned the tide of recovery, so it seems; for now.
Those interventions have also restored investor sentiment from apocalyptic lows in March. As such, the stock market rally from early April has been about as impressive as the nosedive that came before it. But with harsh economic realities now setting in – believed to be the deepest global recession in generations – equities can only run so far on good sentiment. For markets to continue upward, attention has to turn to the actual economic data and activity.
This week, economic data for a number of countries showed that the last quarter (as expected) saw one of the greatest drop-offs in economic activity since records began; and understandably so under the circumstances. The world’s two-largest regional economies, the USA and the European Union (EU), were both severely affected. Worryingly, Germany’s growth figures were worse than expected. However, such data details are often inaccurate on the first release – especially so in the current circumstances – so we should take this with a pinch of salt. Nevertheless, equity markets took a bit of a fright. Worst hit was the UK market, which saw the FTSE 100 drop back below the 6,000 level. Markets had been skittish for a few days – with news of spiking European virus cases and quarantine impositions filtering through – and growth figures pushed sentiment over the edge.
Indeed, all through the last couple of weeks, economic positivity seemed to fade away, only to return with an even greater vigour. Interestingly, the losses of the previous week have been recovered in an unexpected surge last week belying the overall sentiment; with the FTSE 100 moving above the 6,000 mark yet again. This has been partly helped by the US authorities essentially promising to do “what it takes” for a long time. Once again, everyone is talking about the return of some kind of economic gloom, yet the market sentiment seems to ignore this.
The politicians have been doing rather well in coming together to create action during the otherwise disastrous second quarter. However, in the USA, the divisions have reappeared as we head into election season. It is noticeable that the divisions are not just along the traditional Democrat-Republican party line, as a new raft of legislation is due to replace some of the policies introduced by this and previous administrations; not least the healthcare bill and the more recent $600 per week Federal payments to the unemployed, due for renewal. Many see these payments as more generous than necessary, so a proposal to reduce them is unsurprising. However, some believe that the transfer of burden to the states and away from the federal government could be economically disastrous. It seems to be driven by the local election dynamics, not by the needs of the economy. As a sizable proportion of our investments is allocated to North America, their domestic issues (and divisions) go beyond local politics.
A US congressional recess is supposed to start soon and this is the deadline which matters most. As I write, most analysts expect that a political compromise on the due legislation will be achieved before then, with another $1 trillion bill of spending at least. However, yet again, the fragility caused by the partisan US political system is on show, along with the tendency to hold the economy hostage.
Regarding additional spending, President Trump has an incentive to bolster the economy in the near-term. But his longer-term spending plans will not be higher than his rival (given the Democrats’ traditionally looser fiscal policy) and many believe that it is not helping his chances. The stabilisation in virus case growth may be better news, but the president really needs employment to be improving; but the recent improvements have been halted in the past two weeks.
From a more positive point of view, equity markets have helped the worldwide recovery attempts. Across the world, companies have had the busiest couple of weeks ever for earnings announcements, which is in contrast to the recent past when companies have had a torrid time. The larger companies have been relative and, in some cases, absolute beneficiaries of this. These beneficiaries were not just in the USA or EU alone, an indication that worldwide attempts of recovery may be taking root; for now.
Political squabbles ahead of the US presidential election, seemed to have a markedly negative impact on the US dollar. A weaker dollar is usually quite a good thing for the global economy, but a rise of domestic tensions into the winter months may not be. If it were to seize up the US political system at a point when fiscal action is most needed, it could be a very unhappy outcome. The Euro has strengthened rapidly this week, with the biggest gains happening whilst the squabbles in the US increase in intensity.
In general, these sorts of political stories are not that important for markets, but in this unusual time investors seem to be paying them closer attention. Currency stability depends on the trust given to the institutions of authority. For over a hundred years, the most stable have been in the USA. To be relatively weak now, when an economic crisis is still in our midst, may mean that the currency markets could be heading for greater volatility.
In dealing with the economic crisis – just as with the virus itself – policy is crucial. Throughout the worldwide economic shutdown, US authorities have joined their global peers in providing intense and sustained support to a shell-shocked economy. As mentioned in my previous updates, the governments’ fiscal aid programmes worldwide have saved many businesses, and individuals, from going under. Tracking the course of fiscal and monetary policy is therefore an essential part of any outlook on the world’s largest economies. This has led to much greater market confidence than the period immediately after the start of this crisis. However, this can be a double-edged sword. These policies would have to end sooner or later. Experts argue that governments would need to recover much of the money allocated in halting the economic slide. There are only a few ways of doing so and none are going to be liked by the investment markets. Many of the governments’ emergency support measures across the world expire soon and there is already pressure from politicians to reconsider these policies, as the money begins to run out. With the virus cases still spiking across the world and the USA in particular, lawmakers are well aware that renewal of these measures is vital but increasingly unaffordable.
And what of the UK? Afterall, it does occupy (along with North America) one of the largest proportions of our investment portfolios. All that has been said so far also rings true in this country’s economy, with one major exception – Brexit. Yet again, the markets have not reacted to it perhaps because of other distractions, or more likely because it has already been accounted for in their valuations. Either way, experts have been surprised of the resilience of the UK market under all the pressures put on it since June 2016; which in the midst of all the gloom can prove to be the saving grace of this and, for that matter, other world markets.
How does all this affect us as investors? For many of us, who may be wondering if there are any good news on the horizon regarding the future potential of our investments, this is crucial. Equally crucial is how we navigate through the contrasting paths of an uncertain world economy (still finding its way out the crisis) and the investment markets which seem to behave in a totally different way; often acting as though the crisis is over.
Perhaps understanding this contrast, may help explain the different behaviours. Here are some points to consider:
Overall, the current market sentiment seems to be more optimistic than in the past few weeks, bourne from the fact that investment institutions have learned many lessons recently. This translates to a greater confidence that they are in a better position to confront (and address) whatever is yet to come.
Definitions
Earlier in this commentary, I mentioned some technical terms which may require additional clarification:
Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money supply and, therefore liquidity. These two policies are used in various combinations to direct a country's economic goals.
Liquidity means how quickly you can access cash. In simpler terms, it is the ability to get money whenever you need it. In the case of governments, liquidity is the means by which they control money circulation in the economy; for example, through either borrowing or printing more money.
May 2020 will be remembered for many things. For most of the world, it was when lockdown measures began to ease and people filtered back out of their homes for the first time in weeks. Although it could be argued that markets are enjoying an uncomfortably good pandemic that commenced back in April, sadly it was also when the size of the economic problem facing us become abundantly clear. Unemployment numbers in all the developed countries have seen uncomfortably high increases, especially in April. Initial indications in May show little improvement.
Big companies have rolled out global restructuring plans to cut employees and costs, and the depth of this government-directed recession has grown clearer by the day. The policy problem facing governments – how to balance equally enormous health and economic concerns – was a constant concern throughout the month.
Politically, May was fractious as ever. Events in Hong Kong dramatically heightening tensions between China and the US. The United States are currently experiencing another bout of widespread protests countrywide, which have not gone unnoticed by the investment markets.
Despite all this, from an investment point of view, May is likely to be remembered for entirely opposite reasons. Despite the turmoil, equity (stocks and shares) markets around the world continued to soar. Oil prices, languishing during April, had their best ever month – climbing 45.8%. These moves have left stock valuations at eye-watering levels. From an investment perspective, perhaps the word that best sums up May 2020 is ‘disconnect’.
From an outside perspective, it might look like capital markets are in their own fantasy world, blissfully unaware of the chaos that surrounds them. But markets are not just running on hot air. First, the unprecedented support measures from governments and (particularly) central banks have left the financial system awash with cash and overall liquidity. The abundance of capital to spend has drastically lowered the risk premium (the return investors demand for a given level of risk) across all asset classes – with equity still offering one of the highest. Second, we have seen a substantial increase in demand for capital investments from retail investors. The public is putting its lockdown savings to work in ‘capital markets’, adding further to global liquidity. Capital markets is the part of a financial system concerned with raising capital by dealing in shares, bonds, and other long-term investments.
This is the view of one prominent investment manager: “These factors change the way we look at markets. While the pulse of the global economy is indeed slowing, we must remind ourselves that it is doing so because governments are putting it into an induced coma – which is temporary. Most businesses around the world have taken a huge hit to their earnings and balance sheets, but this is true for (almost) everyone, so few have a competitive advantage. At the same time, governments have made it their mission to ensure companies and individuals do not go bust as a result of the pandemic. And since the threat of systemic and widespread bankruptcies appears removed for now, the question appears not to be “should I invest?” but “where should I invest?” This is why assets that offer even a mildly better return prospect beyond the next few months – that is, equities – are doing so well. It also explains why the growth-intensive US technology sector has performed so well – posting a 9.1% gain in sterling terms last month. The current capital market mood stands in stark contrast to a few months ago, when investors were selling everything not nailed down in a panicked frenzy. By contrast, markets now definitely seem to be in a ‘risk-on’ phase, despite there being a plethora of risks around.”
Many experts believe that this makes sense given the above factors, but it makes for uncomfortable reading, nonetheless. Just as the sell-off from late February quickly spiralled lower than could be justified by reasonable economic expectations, the higher the current rally goes the more detached it becomes from economic reality; and the increased market volatility (even by recent standards) experienced in the last few days exemplifies this sentiment.
There are, thankfully, reasons to be positive about the global economy over the medium term. These are mostly based on the speed at which countries are ‘opening up’, but long-term fiscal factors through government support are also a huge part. An example of this is the actions taken by Germany to stimulate the economy and prevent a long-term recession. It is the same throughout Europe. Even if few European countries are able to churn out fiscal support at the same scale as Germany, a pan-European response is also in the making. Joint fiscal plans are being proposed and stubborn political barriers being broken faster than we have seen in years – all pointing to genuine progress on the horizon.
The first priority of a government, we are told, is to protect its citizens. The speed at which lockdown measures were imposed around the world in the wake of this pandemic (even by those relatively slow-to-react countries) is a testament to that. But as case rates start to fall across most of the world, ‘protection’ gets a little ambiguous. As policymakers are well aware, maintaining people’s livelihoods can be just as important as saving lives from the virus. This is why most governments (in the developed world at least) have also embarked on huge stimulus and support programmes to see us through the current economic hibernation. It is also why many are now eager to ease lockdown measures and wake the economy up again.
From an investment perspective, tracking the economic recovery is vital. The traditional indicators suggest most of the world’s largest economies have started to rebound. For Europe, the US and Japan, the low point came in late March to early April, when sudden and strict limits were put in place. This can be seen through data obtained from various business surveys at the time, which showed a decrease in business activity (and confidence), signalling ongoing contraction. Recent surveys have indicated an increase in both activity and confidence, albeit relative to the current conditions. But given the unprecedented nature of the pandemic and the economic collapse it has wrought, traditional indicators might not be the best ones right now. Such data paints a detailed picture of the restrained economy right now, but for consumers, businesses and markets, the bigger question is what it might look like in the future. For the short-term at least, this is almost entirely dictated by government lockdown measures rather than actual economic activity.
The recession we are now in is the result of government-ordered measures, and the message is that social distancing and travel restrictions will remain in place for the foreseeable future. But those actions will have a huge economic impact for as long as they are around.
So far, governments and central banks in the developed world have been good at plugging the gap created by the lockdown shortfall. Few think that the furlough and emergency loan and grant support schemes should be ended while the restrictions remain in place, as many businesses and employees are currently reliant on these measures for survival. But even with incentives to keep employees on the payroll, some businesses have started cutting jobs and hiking prices in anticipation of lasting changes in consumer behaviours. The main fear is that, after lockdown measures have largely subsided, the economy might spiral into a ‘classical’ recession, similar to those experienced in the past. If bankruptcies and job losses become widespread, business and consumer sentiment could sink to the point where demand is too weak to support a recovery to pre-pandemic levels over the medium-term.
It is very clear that in order to move forwards, we probably have little choice but to be prepared to open up certain aspects of our previous lives, for the benefit of both the country’s mental health as well as the wellbeing of the economy. We will know soon enough whether these first steps back to the new normal creates a second wave in infections, which would in all probability be a game changer. If one should be grateful for small mercies, we can be thankful that this pandemic started at the end of the winter, and not the beginning. Only time will tell whether the tug of war between a deep (but possibly short) economic downturn and such easy money wins out in determining where markets go next.
So how are the above affecting our investments. To cope with this dilemma, investment managers continue to position portfolios for all eventualities, as much as it is possible. They remain neutrally committed to equity markets in order not to miss out; and remain happy supporting, in particular, both the US equity market and the dollar itself. The lower risk element of portfolios is represented by a variety of fixed interest assets, including inflation linked and credit, where managers believe there is exceptional value to be found. They also hold liquid alternatives that can make modest headway even in falling markets; these various investments, plus some cash, will act as the stabilisers if they see a return to more unsettled conditions. When logging-in to view your investments, you would have notice that the ‘cash’ element of your portfolio(s) is much higher than you have seen in the past, for just this reason.
I am aware that reading much of the above commentary will not provide you with much comfort. The reality is that the uncertainty we have been experiencing in the last few weeks is still there, as is the investment volatility. However, for those of us who have been closely monitoring the performance of our investments recently, we can see that much of the losses of March and April have been ‘recovered’, for now at least. It is also noticeable that the fund managers, to their credit, have produced results which prevented the severe downturns experienced in the equity markets in recent months; sparing us a greater portfolio contraction than that which has been experienced elsewhere.
What it is different now is that the ‘surprise factor’ of what had happened in those months is no longer there and fund managers have more understanding of the new economic environment. This means that they should, one hopes, have the tools to deal with any future downturn more robustly. The changes they have been making in our portfolios recently should be the start of this, but none will be surprised if we encounter another financial shock similar to that in March. It is hoped that this time, they ought to be more prepared and equipped to deal with it. However, the wide-held belief is that we are unlikely to go back to how things were and the winners and losers of the past are not going to be the same once the ‘new normal’ is established.
The feedback that I am getting from my various conversations with clients is that this is a short-term occurrence in what is effectively a long-term investment approach. Nevertheless, we are all reliant on the investment managers we have entrusted with our money to do the best they can under the circumstances. They have the tools and the expertise to do so and the indications so far are that they are beginning to produce the results, which will hopefully meet our expectations. However, we have to be mindful that things will never be the same again and the new economic (and financial) realities in the future will be much different; yet, still rewarding.
The theme since our last communication has been the question of whether the market recovery in April would continue, or if we would go back to the volatile times experienced in March. So far this month we have seen the volatility returning but not at the previous levels. However, most of the gains experienced in April are still embedded in the various markets, prompting many observers to conclude that there could be more to come in the near future. This sentiment seems to be prevalent throughout the fund management community, but there is also some measured caution. As one fund manager put it:
“May’s start has seen some wobbles and confidence is fragile. The bad news is that the economy is still in hospital. The good news is, so far, that policies have been reasonably successful in putting businesses to sleep rather than killing them, news on treatments is mildly positive and a slow “opening-up” is underway. For investors, patience will probably be rewarded.”
This view has been partly influenced by what authorities are trying to do in an effort to stimulate ‘recovery’, or at least ‘curb’ recession. Government spending, on a global scale, is at historically high levels and only comparable to that incurred during World War II. With economies around the world shut down, policymakers have been rolling out huge fiscal packages to ensure businesses and individuals get through the tough times. The belief is that with businesses in hibernation, the cash drain through the bump-up in spending will be worsened – in the short term at least – by falling tax revenues. Most governments agree that the combined budget hole this opens up needs to be filled with public borrowing, and that this debt will have to be financed by huge monetary interventions from central banks. The UK, US, France and Spain are all expected to end this year with much higher debts than in recent years, while the figures for Italy and Japan are even higher than anticipated.
Those inclined to look further ahead are understandably worried about the long-term implications of this burgeoning debt load, but no one seriously thinks those worries should stop governments from spending now. Without measures to bridge the gap from here to normality, economies and people’s livelihoods would be in ruin – making a swift recovery all but impossible. Even beyond the end of lockdown, there is an increasing sense that genuine long-term public investment is needed. For now, the usual “can we afford it?” rhetoric that accompanies any fiscal (government revenue related) stimulus discussion is largely absent. But not all countries will have equal ability to borrow and spend. Governments trusted by investors (through past fiscal prudence, reserve currency status or otherwise) will do better in the balancing act than others.
At this stage, it is important to point out that there is no ‘one size fits all’ level of government debt. Japan has done no worse than other developed nations, yet has more than double this type of debt compared to many other countries. While some evidence suggests that debt-financed spending usually becomes less effective the more a government does it, the current scenario is anything but usual. Even in normal times, the crucial issue is not “how much debt does a government have?” but “how sustainable is it?” – since debt levels and deficits are linked to interest payments. As a rule of thumb, a country’s debt is deemed sustainable (or stable) if the government is able to make interest payments on its debt because the revenue is sufficient enough (or greater) to do so. Like any other debtor, if the repayments are affordable then the debt is sustainable. This, of course is assuming that the government’s tax receipts fully cover its spending in the first place.
Interestingly enough (and crucially), maintaining a stable debt repayment regime does not always mean lowering debt levels. Debt can rise as long as government income rises more quickly. Equally, if governments are trying to reduce debt through austerity, revenue could (and if pursued right now almost certainly would) fall much faster than the pace at which debt is being repaid.
In fact, there is currently a popular line of thought that austerity – and even borrowing for that matter – is never necessary if the state can print its own money. This, of course, requires the government to have perfect foresight on the arrival of inflation, and be motivated to counter it. This would go against the prevailing belief that an independent central bank should take care of handling inflation.
That may seem an extreme position, but it does remind observers of what central banks are doing right now. Huge fiscal stimulus programmes by governments are being funded by practically unlimited borrowing from various sources. In effect, government spending is being ‘monetised’ as authorities are just printing the money they need. Central bankers have been quick to point out that their aim is carrying over the economy through lower yields and supporting demand, rather than plugging budget holes.
The impact of this longer term can only be felt once we know if the recovery would be swift, or longer lasting. Either way, that debt would need to be reduced at some stage and funding for it can only realistically come from few sources, and taxation (in whichever guise it may take) in particular. There is no doubt that some countries (and regions for that matter) would be more able to carry out this ‘recovery’ than others. Therefore, identifying this by fund managers would be fundamentally important in what would happen to their investment approach in the future.
What happens to the investment markets is also dependent on other major events, both current and those due in the near future. Here are some of these:
We are all watching closely the news outlets for the latest developments and it is easy to feel despondent with all the negative news we are presented with. There is, however, a sense of optimism that we have gone through crises like this before and human nature has the ability to learn from them; and the world would come out of this much stronger.
This is the fourth ‘update’ sent to our clients in the last few weeks and some have already commented on the “pessimistic” (or ‘realistic’, depending on one’s point of view) nature of the observations. Others saw it differently. The reality, I would argue, is somewhere in between. There will be winners and losers out of what we are going through and like in any other part of our lives the investment sector would have the same experience.
The key element of this, is the ability of the fund managers we have entrusted with our investments to do so prudently and effectively. They would need to identify the investment opportunities with the potential to navigate safely through these difficult times and the ability to thrive post the crisis. Not all would achieve this and we, as advisers, need to identify the potential winners and steer away from the rest. During the last few weeks of ‘lockdown’ I have been having numerous conversations on a daily basis with many of the investment managers in the industry, all of whom were keen to emphasise that the long-term prospects of investment activity are still positive.
Nevertheless, we are entering a different phase in the days ahead. The loosening of lockdowns means a partial restarting of the wider economy, but also the chance of rises in reported cases. That may increase the risk of restrictions being tightened again. As such, markets could find the going to be quite a bit heavier – they may have to transition from not worrying too much about the present to having to gauge the likely speed of recovery once extraordinary support measures are gradually withdrawn. For this brave new experience to be successful, good behaviour – and a commitment to ensuring everybody ‘stays safe’– will be required from citizens, communities and governments.
Many believe that our world would not be the same when we exit this crisis and the question still remains whether, as is the case with the ‘flu’, coronavirus is here to stay. Regardless of it, whether this is a true sentiment or not, the fact remains that there would be opportunities for investors that are either new or have now come to the fore. Let us consider some of these:
In short, the above indicate that what were investment opportunities in the past may be replaced by new ones now. The feedback from the investment managers clearly indicates that these changes are already taking place and which, they feel, will drive the next ‘revolution of change’ in human activity. Irrespective of the above, there are indications that once we have weathered the latest storm nature put in our way, the potential for a brighter investment future may not be far away. The key question here, however, is how many investors are willing to persevere and show patience to that end.
The post-Easter week brought continued relief for long-term investors, with a consolidation of the recovery from the past few weeks. As discussed previously, Investment Managers believe that two scenarios remain rational and entirely possible:
a) New lows may lie ahead and
b) The worst is behind, because investors at large now consider holding equities (stocks and shares) to be the preferable long-term option, compared with holding cash or low risk assets. This decision is reached by weighing short-term downside risks against the medium-term “certainty” that there will be a post-coronavirus recovery.
The latter scenario came increasingly into focus last (and so far, this) week, as the balance of public opinion shifted from open-ended blanket activity constraints to a gradual re-opening of public life and the economy across differing age groups. This perception would have been promoted by a combination of falling new hospital admissions, reports of coping healthcare systems and increasing economic hardship pressures experienced in various degrees worldwide. This has also been helped by some quite encouraging news on the treatment of the virus, through some of the front runners amongst the anti-viral drugs undergoing testing in hospitals around the world.
While it is still very early days to assume that the peak of the global COVID-19 epidemic has passed earlier than modelled, the feedback is that experts are starting to believe that the key reasons for full lockdowns are beginning to dissipate. This is based on statistical evidence which has indicated that the infection is most dangerous for the elderly and infirm, who are at elevated risk of infection when the virus spreads uncontrolled through communities. It is believed that once this group has been shielded from wider community contact (as has been the case in the UK after communal contact peaked in late March) hospital admissions and fatalities could potentially reduce. However, dangers do persist for the rest of us despite some positive reports, as a widely distributed vaccine looks unlikely to appear any time soon. Therefore, it is understandable why so much (market) hope and excitement is attached to any positive news from the antiviral drug tests; however misguided this sentiment may/may not prove to be under the circumstances.
On the one hand, hope is powerful but can lead to over-optimism. We cannot be sure whether the latest developments are reason enough to follow China’s example and end the blanket restrictions of free movement across society. The experience of those countries across Continental Europe, who are now daring to ease their national lockdowns, will be most instructive for those who are a few weeks behind in the epidemic. On the other hand, the expert view is that should re-opening society lead to renewed spikes in hospital admissions, or the tests on antiviral drugs return inconclusive results, it may mean further lockdowns could be necessary.
Investment Managers think markets are currently choosing to focus on the former rather than the latter. Being awash with central bank liquidity and considerable economic stimulus, could keep them propelling upwards. Whether this proves to be justified or wishful thinking, only the coming weeks will tell. However, positioning their investment strategy decisively towards one outcome or the other seems high-risk at this point, as recent events have clearly indicated.
Understandably, investors have great concerns and rightly so, especially when confronted by all the bad news we are constantly ‘bombarded’ with on a daily basis. Therefore, reliance on Investment Managers to make the correct decisions on our behalf becomes even more significant; and some reassurance is imperative.
For the time being, the indications are that stock markets seem to have found a ‘floor’. After being in freefall throughout March, equities have rebounded strongly over the last couple of weeks and have now entered a period of consolidation. Major indices in the US, UK and Europe all held onto recent gains. The newfound market confidence stands in stark contrast to the sheer panic so prevalent in March, when investors joined in with frantic doomsday preparations by selling everything that was not nailed down!
March’s chaotic sell-off stemmed from the fact that this pandemic – and the enforced shutdown – has plunged us into a recession of unknown depth or duration. But the basis for the stock market rebound has nothing to do with actual economic recovery. We are still very much in an economic ‘coma’, with the latest data beginning to show the consequences of the shutdown. Faith in markets has instead come from the resolve of governments and central banks to do whatever it takes to beat, not just the virus itself but the economic harm it will bring. Policymakers have effectively thrown a safety net under the financial system and wider economy.
For asset markets, the biggest component of this is probably central bank action. Central banks around the world have effectively written blank cheques to their respective governments (and in some cases, corporate debt markets) and promised to ensure the financial system is awash with liquidity/cash. For the real economy, the most important element is how governments spend that money. Huge fiscal packages have been pledged to support businesses and consumers through the tough months ahead. But despite the promises of politicians that no one will be allowed to go under from this natural catastrophe, in practice that may prove easier said than done.
In the UK, for example, the emergency assistance package through the Coronavirus Job Retention Scheme – whereby the government pays a significant amount of furloughed employees’ wages – is in theory the simplest and most accessible of emergency measures introduced. Indeed, there are reports that businesses are taking advantage of it to good effect. There is also the Coronavirus Business Interruption Loan Scheme, which only time will tell if it proves to be successful. In the USA, the ‘CARES Act’ primarily provides loans, with potential ‘forgiveness’ for those which came under the ‘Paycheck Protection Program (PPP)’. Indications so far are that the pace of take-up has been considerable, which in turn will have an impact on the US markets.
Although it is already too late for some companies, politicians maintain government action has avoided the tumbling domino effect of corporate defaults. But all the political will in the world cannot stop a business going insolvent if the transmission mechanisms (banks/lenders, for example) are not able to pump the money and quickly enough to make a difference.
Despite these issues, stock markets are continuing their recovery. The question remains whether investors are simply not aware of the problems posed by systemic defaults in small and medium-sized enterprises. To this end, it is worth remembering that the major equity indices around the world feature the largest companies, for whom financing is usually not too hard to come by; and are best equipped to weather the current financial storm. Investment Managers do not only rely on these companies for their portfolio creation, as they often believe that ‘smaller’ companies could offer greater potential and value for money. Therefore, what happens to an investor’s individual portfolio is not always a reflection of these stock markets and how they perform.
Nevertheless, a spiralling default cycle – the domino effect mentioned earlier – would be a huge blow to the economy overall, because it would hinder economic activity as businesses become increasingly reluctant to rely on and trust each another for order fulfilment. If markets expect this to happen, we may see another huge sell-off, even if the short-term prospects for the largest companies were not so dire. Experts believe that the fact that markets are not selling off, therefore, suggests this scenario is not expected; and the reason for this, many experts suspect, is once again policymakers’ resolve. Even with the ‘transmission’ issues highlighted, should defaults start to ratchet up, there is the potential for governments to undoubtedly increase their support.
This commentary has been collated through the feedback received from various Investment Managers, many of whom are responsible for managing our various portfolios. The overall consensus from these sources is that optimism now is higher than when this ‘crisis’ began. Whether this would continue, only time will tell. Suffice to say, in the event that there is a need to make changes to your portfolio(s) they will do so if and when required. In the meantime, we will continue to keep you updated through our various communications.
The post-Easter week brought continued relief for long-term investors, with a consolidation of the recovery from the past few weeks. As discussed previously, Investment Managers believe that two scenarios remain rational and entirely possible:
a) New lows may lie ahead and
b) The worst is behind, because investors at large now consider holding equities (stocks and shares) to be the preferable long-term option, compared with holding cash or low risk assets. This decision is reached by weighing short-term downside risks against the medium-term “certainty” that there will be a post-coronavirus recovery.
The latter scenario came increasingly into focus last (and so far, this) week, as the balance of public opinion shifted from open-ended blanket activity constraints to a gradual re-opening of public life and the economy across differing age groups. This perception would have been promoted by a combination of falling new hospital admissions, reports of coping healthcare systems and increasing economic hardship pressures experienced in various degrees worldwide. This has also been helped by some quite encouraging news on the treatment of the virus, through some of the front runners amongst the anti-viral drugs undergoing testing in hospitals around the world.
While it is still very early days to assume that the peak of the global COVID-19 epidemic has passed earlier than modelled, the feedback is that experts are starting to believe that the key reasons for full lockdowns are beginning to dissipate. This is based on statistical evidence which has indicated that the infection is most dangerous for the elderly and infirm, who are at elevated risk of infection when the virus spreads uncontrolled through communities. It is believed that once this group has been shielded from wider community contact (as has been the case in the UK after communal contact peaked in late March) hospital admissions and fatalities could potentially reduce. However, dangers do persist for the rest of us despite some positive reports, as a widely distributed vaccine looks unlikely to appear any time soon. Therefore, it is understandable why so much (market) hope and excitement is attached to any positive news from the antiviral drug tests; however misguided this sentiment may/may not prove to be under the circumstances.
On the one hand, hope is powerful but can lead to over-optimism. We cannot be sure whether the latest developments are reason enough to follow China’s example and end the blanket restrictions of free movement across society. The experience of those countries across Continental Europe, who are now daring to ease their national lockdowns, will be most instructive for those who are a few weeks behind in the epidemic. On the other hand, the expert view is that should re-opening society lead to renewed spikes in hospital admissions, or the tests on antiviral drugs return inconclusive results, it may mean further lockdowns could be necessary.
Investment Managers think markets are currently choosing to focus on the former rather than the latter. Being awash with central bank liquidity and considerable economic stimulus, could keep them propelling upwards. Whether this proves to be justified or wishful thinking, only the coming weeks will tell. However, positioning their investment strategy decisively towards one outcome or the other seems high-risk at this point, as recent events have clearly indicated.
Understandably, investors have great concerns and rightly so, especially when confronted by all the bad news we are constantly ‘bombarded’ with on a daily basis. Therefore, reliance on Investment Managers to make the correct decisions on our behalf becomes even more significant; and some reassurance is imperative.
For the time being, the indications are that stock markets seem to have found a ‘floor’. After being in freefall throughout March, equities have rebounded strongly over the last couple of weeks and have now entered a period of consolidation. Major indices in the US, UK and Europe all held onto recent gains. The newfound market confidence stands in stark contrast to the sheer panic so prevalent in March, when investors joined in with frantic doomsday preparations by selling everything that was not nailed down!
March’s chaotic sell-off stemmed from the fact that this pandemic – and the enforced shutdown – has plunged us into a recession of unknown depth or duration. But the basis for the stock market rebound has nothing to do with actual economic recovery. We are still very much in an economic ‘coma’, with the latest data beginning to show the consequences of the shutdown. Faith in markets has instead come from the resolve of governments and central banks to do whatever it takes to beat, not just the virus itself but the economic harm it will bring. Policymakers have effectively thrown a safety net under the financial system and wider economy.
For asset markets, the biggest component of this is probably central bank action. Central banks around the world have effectively written blank cheques to their respective governments (and in some cases, corporate debt markets) and promised to ensure the financial system is awash with liquidity/cash. For the real economy, the most important element is how governments spend that money. Huge fiscal packages have been pledged to support businesses and consumers through the tough months ahead. But despite the promises of politicians that no one will be allowed to go under from this natural catastrophe, in practice that may prove easier said than done.
In the UK, for example, the emergency assistance package through the Coronavirus Job Retention Scheme – whereby the government pays a significant amount of furloughed employees’ wages – is in theory the simplest and most accessible of emergency measures introduced. Indeed, there are reports that businesses are taking advantage of it to good effect. There is also the Coronavirus Business Interruption Loan Scheme, which only time will tell if it proves to be successful. In the USA, the ‘CARES Act’ primarily provides loans, with potential ‘forgiveness’ for those which came under the ‘Paycheck Protection Program (PPP)’. Indications so far are that the pace of take-up has been considerable, which in turn will have an impact on the US markets.
Although it is already too late for some companies, politicians maintain government action has avoided the tumbling domino effect of corporate defaults. But all the political will in the world cannot stop a business going insolvent if the transmission mechanisms (banks/lenders, for example) are not able to pump the money and quickly enough to make a difference.
Despite these issues, stock markets are continuing their recovery. The question remains whether investors are simply not aware of the problems posed by systemic defaults in small and medium-sized enterprises. To this end, it is worth remembering that the major equity indices around the world feature the largest companies, for whom financing is usually not too hard to come by; and are best equipped to weather the current financial storm. Investment Managers do not only rely on these companies for their portfolio creation, as they often believe that ‘smaller’ companies could offer greater potential and value for money. Therefore, what happens to an investor’s individual portfolio is not always a reflection of these stock markets and how they perform.
Nevertheless, a spiralling default cycle – the domino effect mentioned earlier – would be a huge blow to the economy overall, because it would hinder economic activity as businesses become increasingly reluctant to rely on and trust each another for order fulfilment. If markets expect this to happen, we may see another huge sell-off, even if the short-term prospects for the largest companies were not so dire. Experts believe that the fact that markets are not selling off, therefore, suggests this scenario is not expected; and the reason for this, many experts suspect, is once again policymakers’ resolve. Even with the ‘transmission’ issues highlighted, should defaults start to ratchet up, there is the potential for governments to undoubtedly increase their support.
This commentary has been collated through the feedback received from various Investment Managers, many of whom are responsible for managing our various portfolios. The overall consensus from these sources is that optimism now is higher than when this ‘crisis’ began. Whether this would continue, only time will tell. Suffice to say, in the event that there is a need to make changes to your portfolio(s) they will do so if and when required. In the meantime, we will continue to keep you updated through our various communications.
During times of such unprecedented uncertainty, some of our clients will be asking themselves what active investment management means under the circumstances and what we, as your advisers and the selected/appointed investment managers, may be doing to manage the impact capital markets are having on portfolio values.
Just as we all want to know what the Government is doing, you may want to know what we (and especially the investment managers) are doing during these difficult times. To put prudent investment management into context, in times of heightened if not unprecedented levels of uncertainty, everybody has a significant urge to ‘do something’ – it is human nature to want to fix something if it goes ‘wrong’. The general panic buying we are currently experiencing, against best advice from the Government and the supply chain managers, is a testimony to this very human notion.
Financial markets have separately and simultaneously had to contend with an oil price war that has contributed in no small way to a highly unstable and uncertain backdrop. It is quite clear that we are now moving into a new phase of uncertainty. We can expect further unprecedented measures to be announced by central banks and governments in the coming days and weeks aimed at preventing the likely recession from turning into a full-blown financial crisis and economic depression. But how deep this economic downturn will be, how quickly we will come through it, and who the survivors will be, are still questions which are virtually impossible to answer at present.
Investment managers and portfolio managers in particular face the same pressure when markets and asset classes embark on a wild ‘yo-yo-like’ pattern of daily movements. However, even if it runs against the human desire to intervene, ‘doing nothing’ is widely accepted as the best approach to:
a) preserve the volatility reducing characteristics of diversified portfolios vs. direct stock holdings and
b) to have portfolios in a position to act at the point when the wild market swings calm and the biggest buying opportunities arise.
This does not mean that the investment teams responsible for your portfolio(s) have been sitting idle. Nothing could be further from the truth. Every day, our appointed investment management teams review the relative weightings across portfolios and reflect against the market developments whether the portfolios’ individual component parts have drifted to a positioning – driven by differing asset class returns – that they deem adequate and appropriate.
While the portfolio is continued to be monitored as a whole, they are constantly reviewing those individual component parts; thus, ensuring that the underlying funds which make up these portfolios perform as expected, through the prevailing market environment. It is also expected that the ‘active managers’ are taking advantage of the recent volatility in markets. Furthermore, for our part, we want to ensure that they remain committed to the philosophies, which led us to selected them in the first place.
With a reduction of stock market valuations of over 30% since their February highs, there are arguably buying opportunities appearing in the equity markets. However, we need to understand (and accept) that uncertainty over the extent and timing of an economic rebound remains exceedingly high and we are only four weeks into this downturn. It is quite likely that we will potentially – even if just temporarily - see lower lows over the coming weeks.
Trying to ‘time-the-market’ and trade on short-term swings is the reserve of the very highest risk seekers amongst investors. It could be argued that those with a capacity for risk, who choose to go it alone, could lose significant amounts of their capital (or miss any short-sharp recoveries) if they misjudge the sudden turns of disorderly markets and guess wrong. Your investment team, as medium to long term managers, will not be drawn into ‘gambling’ with client savings entrusted to their investment management; as we firmly believe that ‘time in the markets’ will once again prevail, just as it has done during all previous ‘apocalyptic’ looking global crises.
On a separate note, our operations at DSN Financial Limited remain fully functional with all the team still working as usual. In the event that we need to make changes, we have put contingency arrangements in place so each member can work from home, with the minimum disruption. In this way, we can reduce any disruption to a minimum, can continue our service, maintain communications with you and respond to any enquiries you may have.
Kind Regards,
Doros Nicolaou
DSN Financial Limited
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