Tick tock: coming to a head
High summer was once known as silly season. Not this year. As global coronavirus cases exceeded 19m and the pace of economic re-openings sputtered, the focus has moved to the extension of stimulus packages, the end of furlough assistance and ongoing corporate strain.
The clock is ticking on consumer confidence, which has been tided over by stimulus, incentives and extraordinary coronavirus-related hardship payments. Distractions abound, too, such as the ongoing US-China trade tensions, political posturing in the run-up to the US election, Brexit discussions and, somewhat unusually, President Trump’s possible ban on popular teen-platform TikTok.
Alphabet soup: what shape will the recovery take?
As the v-shaped market recovery recedes in the rear-view mirror, our Economics team believes the consensus is moving away from a short, sharp rebound in economic growth. Global Q2 GDP numbers were staggering: UK GDP shrank by 20% and the US economy contracted by 32.9% – both record declines.
It is becoming clear that up to a decade of growth could be wiped out in just one quarter. The task of regaining this growth is illustrated by labour markets: in the US, a net 13.2m jobs have been lost. On the basis that 1.5m jobs were added last month, it would require nine months of similar growth to recover them – and this might be considered a best-case scenario.
Fixed income: the reach for yield
Looking forward, interest-rate policy is expected to stay loose – especially in the US, where there is up to $600-700bn of quantitative easing (QE) a month. In the UK, there are already de-factor negative rates and an additional £100bn-worth of QE is expected.
This has had a direct impact on fixed-income valuations – and particularly on US high yield, where the additional impact of compressed supply over the summer helped the asset class record its best month since 2011.
These technical factors may obscure what our Fixed Income team believes are fundamental issues – such as the rise in leverage – with corporates, although it is difficult to see what would alter the demand for bonds in this low-yield environment. Ultimately, we are likely to see a more nuanced differentiation between issuers and their long-term outlook – although only time is likely to confer this.
Equities: distinguishing factors
Equity markets have held their own throughout the summer, particularly in the US and Asia. Our teams have also noticed more stock-specific differentiation, as earnings season has revealed the diverging effects of the pandemic on individual companies.
This reassures us that it may not be just a select few large tech stocks that determine portfolio outperformance. In particular, our Impact Opportunities team has noticed increased momentum around stocks levered to the circular economy and educational and financial inclusion, as well as life-sciences companies which may benefit from the extraordinary collective research effort surrounding a coronavirus vaccine.
Elsewhere, our Global Equities team notes the resilience of those companies that have stayed firm in their commitment to sustainability and environmental, social and governance issues. It has become clear that the market’s treatment of companies that violate expected norms is swift and decisive. For example, Boohoo Group lost close to half of its value in the two weeks to 15 July following allegations of sweatshop practices at two of its UK-based suppliers.
The market is weighing both the reputational damage of the scandal as well as the likely impact that remedying it will have on margins. This suggests that investors are not laser-focused on profitability at ‘any’ price but instead have become more discerning.
Gold: ready for take-off
The influx of stimulus means that all assets – and equities in particular – have been squeezed higher in value. Our Multi Asset team has analysed the cyclically adjusted price earnings (CAPE) ratio, which ten years ago anticipated a 10% return on equities. In fact, the market delivered 15%. They believe that equities are ripe for a mean reversion, with the CAPE indicating the return on equities over the next decade could be less than 4%.
However, the team notes that other asset classes – such as US Treasuries – are also expensive by historical standards. There is ongoing crowding in certain trades, especially tech stocks, while long-term risks abound – namely the US election in November and the associated potential for changes to the corporate tax rate and tighter anti-trust policies.
Extreme monetary and fiscal expansion, a low-cost opportunity with government bond yields close to zero and a compressed CAPE all suggest that gold is poised to outperform equities over the next decade – something that is likely to benefit commodities and other real assets.
Real estate: a brave new world?
Real estate has remained a nerve centre of consumer and corporate woes. Yet as the pandemic-related disruptions are prolonged, our Real Estate team believes that the outlook is complex but not entirely negative.
In a series of recent webinars, our team argues that people will ultimately continue to seek out spaces for social interaction and collaboration. Because of this, office spaces will change to accommodate new transport realities and employee expectations – such as by providing more parking and bike storage – while retail properties will evolve at an accelerated pace.
Although tenant solvency is likely to cloud valuations and transactions in the immediate future, the impetus around regeneration and sustainability will offer opportunities for investors over the long term.