Economic Performance & Outlook
Rarely before has the news and the global political backdrop, dominated by the reaction to Covid-19, been so closely and clearly intertwined with the economic environment. The debate over how to balance our desire to limit infections and deaths with the need to keep the economy afloat dominates the agenda.
Notwithstanding the very significant risks that are appearing across Europe as infection rates rise again, as a company, we do believe that things are stabilising and will improve further as we move into 2021. The very public illness of US president Donald Trump showed that medical professionals do indeed now have a range of treatments to try and lower the risks and dampen the symptoms of Covid infection. With many countries and drug companies around the world investing heavily in the search for a vaccine, some appear to be getting closer to success, and the head of the UK’s task force for vaccines has indicated that they think there will likely be something available by the early part of 2021.
However we also need to acknowledge that the economic damage from this crisis has been severe and will be long-lasting. Retail and hospitality, which provide the lifeblood of urban centres and support the wages of many, particularly lower-earning individuals, have been hard hit. Consumer behaviour has not only been dampened, but altered, so that longer-term trends towards internet shopping and away from the high street have been vastly accelerated by the crisis.
To mitigate the worst of these effects, governments have taken gargantuan measures to maintain a degree of stability. Across Europe and somewhat in the United States, governments have virtually guaranteed the income of many workers in threatened industries, allowing companies the ability to at least attempt to get through the crisis. But this all costs money – a lot of it.
We expect that political parties will increasingly advertise their willingness to spend, and electorates will likely reward those who offer government spending as a way to lift people out of difficulties. The effect on government balance sheets will be felt for many years and the debts racked up in recent months mean borrowing levels are, and will remain, significantly higher than they were over the previous decade.
At the same time, central banks have reacted promptly and strongly, pumping huge amounts of money into the economy and driving interest rates from historically low levels even lower. The Bank of England recently asked lenders if they were ready for negative interest rates, a sign from policymakers that we may have to advance even further into a highly-supported monetary environment.
Framing our current decision making are five significant outcomes of the pandemic:
- Government borrowing will remain at increased levels for some time.
- Higher spending on health, infrastructure and employment will probably mean higher taxes.
- Inflation will be difficult to predict because of increased government spending coupled with increased monetary supply against depressed consumer demand and rising unemployment.
- Existing consumer and business trends such as those in retail and transport will accelerate.
- The crisis may provide space for concerted effort to tackle climate change, with attendant risks and opportunities for businesses and investors.
Bond performance over past year
All bonds 10+ years, 21/10/2019 – 21/10/2020, local pricing
The US 10-year Treasury yield, the global benchmark for government bonds, dipped sharply between January and March this year before arresting its decline, hovering most of the time since between 0.5 and 1 per cent.
In Europe the ability of leaders to agree on a shared support package for those suffering most from Covid, in stark contrast to earlier attempts to share burdens across national borders within the EU, has led to a decline in the spread of so-called peripheral bond yields over the European benchmark German bond yield. This in effect shows that fears for the economic well-being of Europe’s peripheral economies have been subdued, bringing yields more in line with what investors consider the safest European debt of Germany. Elsewhere, high yield spreads widened earlier in the year with increased fears of higher default levels, but they have reduced somewhat since.
Equity performance over past year
21/10/2019 – 21/10/2020, local pricing
Whatever your thoughts about the decline or otherwise of the US, its economy and stock market are still the largest in the world, and have therefore provided the headlines for the global market response to Covid-19. The benchmark S&P 500 index has climbed over 15 per cent in the past year, but even more informative is the 40 per cent rise in the technology heavy Nasdaq index over the same period.
This shows clearly what has become evident in the crisis – that while there might be many losers, there are also a significant number of winners as the pandemic and lockdown measures accelerate existing trends in areas such as internet retail. Thus it is clear that a large part of the continuing buoyancy in equity markets is down to the success of the technology winners, with Microsoft, Apple, Amazon, Alphabet and Facebook now worth almost three times the size of the total FTSE 100 index.
It will come as no surprise that the Covid crisis has hit European property strongly, most notably in areas such as retail, and with the long-term impact on sectors such as prime offices yet to be determined. For this reason we are unable to recommend property as an investment in the short term and we recommend clients who were below their target weight remain there.
Commodity performance over past year against equities
21/10/2019 – 21/10/2020, US dollars
As the global economy slows, demand for energy has retreated driving the oil price lower. The current price of around 40 dollars is well below the 60 dollar price being paid as 2020 began.
Over the longer term there may be opportunities in other commodities, as a switch from carbon-based energy to renewable methods becomes more entrenched. Examples of such commodities could be nickel and copper, which are needed for electricity distribution.
Hedge fund performance over past year against equities
21/10/2019 – 21/10/2020, US dollars, hedge funds priced monthly
Hedge funds did provide a degree of protection to investors during the sharp fall in markets seen in March, but performance in general continues to disappoint. Multi-strategy vehicles have performed best, returning more than 10 per cent on average in the first eight months of 2020.
There have been a number of sharp movements in currencies in recent months, and, depending on the side where you find yourself, the opportunity for gains or losses. These funds are likely to remain useful for diversified investments, but can exhibit significant volatility over the short term, so are only suitable for long-term investors.
Global Tactical Asset Allocation Funds
Because of the wide range of investments held by these funds, they provide good diversification opportunities for investors. They have, however, yet to prove their worth in return terms.
These floating-rate sub investment grade instruments provide a significant premium return over cash because of their liquidity and credit risks.
Portfolio Structure & Risk Management
- It is very important that clients have a disciplined management framework for determining how to structure portfolios and how to adjust that dynamically over time.
- Acuvest recommends that portfolios comprise a diversified mix of asset types which balances the desire for high returns with management of the associated risks. For this purpose, we group assets into three categories: growth (including equities and property), managed risk (including global tactical asset allocation funds, certain types of hedge funds and sub-investment-grade credit risk) and defensive (including bonds and cash).
- Within clients’ portfolios, we have been running a high cash position, but had advised clients to increase their allocation to equities (from negative to neutral) following the sharp fall in markets in February and March. Given the extent of the recovery in markets despite the uncertain outlook for economic and corporate profitability growth we reverted to a negative stance in August, and continue to work with our clients on finding more attractive investments in credit and infrastructure. Our current central expectation is for high levels of volatility to continue through the rest of this year and we will be looking for dips in the market to provide an opportunity for clients to rebalance, and potentially increase their allocation back to a neutral level.
- In a low-return environment, keeping fees low is particularly important.