Update posted 14 December 2020:
Looking back over the year
What a strange year 2020 has been. Thinking back to January the world was naïve as to what was about to hit. We expected the global economy to fare relatively well this year. However, Covid-19 forced us to completely re-evaluate the economic reality.
The year started amid Trump’s impeachment controversy and the signing of a trade agreement between the US and China. By the end of the month, Covid-19 had entered investors’ radars, but consensus thinking was that it was likely to be a regional issue with China aggressively taking action to combat the disease.
Focus then moved onto the US democratic primaries with a lot of attention on the socialist agendas that we haven’t seen in the US in recent history. However, by late February and early March slowly saw the world wake up to the realisation that Covid-19 was a serious disease, and more importantly, going global. We saw Italy declare the first national lockdown on the 9th March as it became clear that Covid-19 was present in all major regions around the world. Markets very rapidly shifted into fear mode, with a flight to government bonds and all equity indices plummeting. As more cities and countries entered into lockdowns the fear in markets intensified, culminating in evaporating liquidity even in government bonds. This forced a response from the Fed. On the 15th March Jerome Powell announced interest rate cuts and emergency Quantitative Easing (QE). Within a week, equity markets had found their bottom and liquidity returned to bond markets.
Fiscal stimulus packages from governments across the globe followed and April saw a huge resurgence as markets took the view that governments and central bankers would do whatever it took to prevent widespread financial distress. So far, it appears to have worked. Bankruptcies have happened, but at a relatively modest rate, lower bond yields have allowed companies to refinance debt and bolster balance sheets in what has been a blockbuster year for debt issuance. Households and companies are, on aggregate, awash with cash. Governments however are more indebted than ever. The debate around national debt, whether it needs to be repaid or can continue to grow indefinitely referred to as ‘modern monetary theory (MMT)’ is no longer an academic question. Much of the developed world has signed up for this experiment. The unintended consequences and ultimate conclusions remain unclear but hotly debated.
Summer saw a continued rally in equities, particularly growth and technology names that were perceived to benefit with interest rates pinned to the floor. For example, Zoom had quadrupled its share price by July and doubled again before its peak in October. Other growth stocks captured headlines, Tesla being the most notorious and eventually becoming the fifth largest listed US stock, just behind Facebook and larger than Toyota, GM and Ford combined. Joe Biden was selected as the democratic candidate for president which was seen as positive for markets.
September and October were much choppier in terms of market action as we saw a second wave of Covid-19 building across western economies leading to fears of further lockdowns. Of course, these fears proved well founded but the sheer volume of monetary and fiscal action seemed to keep markets rangebound, even as uncertainty increased leading into an increasingly bitter campaign with Trump calling out voter fraud at every opportunity, even before the first ballot was cast.
November saw the election of a new US president in Joe Biden, almost certainly helped by President Trump’s less than stellar response to Covid-19. However, the US senate remains under Republican control. this was touted as the ‘worst case’ outcome for markets on fears that further fiscal stimulus would not be able to pass political gridlock. However, markets reacted positively and news of the first Covid-19 vaccines passing their phase III trials added fuel to the rally, triggering the strongest run-up in stocks since April. Despite all that has unfolded, major equity markets such as the S&P500 and the MSCI World have hit record highs, although more ‘value’ focused markets such as the UK FTSE All Share Index and the Eurostoxx remain in negative territory for the year.
Our “base case” for 2021
The economic outcome in 2021 will be better than that of 2020 but we should not immediately expect that any economic improvement will translate into an easy backdrop for financial markets.
Looking forward to 2021, a huge question in investors’ minds is whether the massive scale of QE with the addition of unprecedented fiscal stimulus prove inflationary which could prove very problematic for central bankers in coming years. Or has the demand for capital structurally reduced, leaving deflation as a big economic threat with very little in the way of ammunition to fight it? Either outcome is plausible but have very different ramifications for asset prices and where investors should look for future returns. If you’re in the inflationary camp, value equities and real assets like property look very attractive here. The deflationary view has long duration and growth equities as a more enticing proposition.
Given the richness of all asset prices, and the extreme potential divergence of future returns we remain relatively balanced in our positioning going into the new year with a slight tilt towards value and ‘carry’-style investments. With vaccines on the way it’s easy to see things improving economically but as we’ve seen this year GDP and asset prices often do not correlate well. So, while we believe that accommodative policy will support markets, our response is to cast our net as wide as possible to target pockets of value. We are not getting carried away and retain defensive holding to keep our portfolios balanced going into the new year.
We wish you and your families a happy and healthy end to this year and all the very best of luck for the year ahead. Thanks again for all your support.
Update posted 25 September 2020:
Since the end of August, equities in general have been flat. Japan has led the way, with Europe not too far behind. Japan has taken a change of leader in its stride, with new Prime Minister Suga expected to continue many of previous Prime Minister Abe’s policies. UK equities and US equities however struggled to make headway. Indeed, the US market was held back by something of an unwind in the large cap US Tech and e-commerce stocks that have led the market upwards over recent months.
It is difficult to pinpoint exactly what drove the reversal in Tech stocks but they had come a long way quickly and perhaps reached the point where the buying power of a large number of US retail investors ran out of steam, driving the correction. What this highlighted was how the broader US and global indices are now dominated by these companies and so when they do well, the broader indices do well and likewise when they pull back, the headline indices suffer.
That said, the correction in these parts of the market has made them more attractive once again. With the US Federal Reserve adjusting its approach to average inflation targeting, the prospect of rate rises seems ever more distant and should help pin bond yields down. This helps support the value of longer-term cash flows such as those from the large cap growth stocks. With the continued central bank purchase of bonds, this helps pump liquidity into capital markets which needs to find a home and we are being careful not to fight too hard against this support.
Other risks on the horizon include Brexit, the US Election and renewed lockdowns putting pressure on economies once again. Brexit negotiations appear to be taking a familiar path and the risk of a hard Brexit (and the accompanying pressure on the pound) has risen with each side trying to improve their negotiating position. The US election is beginning to move into full swing and has the ability to unsettle markets over the coming weeks – just from the uncertainty, as opposed to the actual economic impact of the outcome. With coronavirus cases gathering pace in Europe once again, the potential impact on economic activity has moved into focus again. How governments strike a balance between controlling the virus and keeping economies open will be key from here. We’ll be watching these developments closely, but with these uncertainties unfolding, we continue to retain a degree of caution across the portfolios.
Update posted 21 August 2020:
The last couple of weeks have seen equites move upwards again, but with a slight change in global leadership towards the UK (and smaller companies in the UK) and Japan, both of which have lagged the recovery somewhat in previous weeks. Continued progress in the US more recently has been hindered by an impasse in agreeing the next round of fiscal stimulus. However, this has not prevented the US market reaching new all-time highs.
The Democrats and the Republicans continue to fight over the size and nature of the next round of fiscal support. Whilst previously this had perhaps been seen as something of a done deal given the necessity of the situation, no agreement has been reached as the parties break for the distraction of their annual conventions. This may mean we see instead some kind of fudged, smaller interim solution. In the meantime, without an extension to unemployment benefits, American consumers will start to see less cash in their pockets and a potential curve ball to the gradual return to normality in the States.
Whilst there’s some evidence that the coronavirus case growth that had been troublesome in parts of the US in recent weeks are showing signs of slowing, we’ve seen a tick up in numbers across parts of Europe and other pockets around the globe where countries have tried to re-open after lockdown. It appears that the pickup maybe partly a result of younger generations taking fuller advantage of the easing of lockdown rules as death rates are not rising at a similar rate, as we perhaps become better at treating patients and shielding the most vulnerable. However, from an economic recovery point of view, an increasing number of local lockdowns and re-imposed quarantine rules will certainly slow down the recovery and create further uncertainty for businesses.
Markets appear to be facing several headwinds right now, from coronavirus case growth to geopolitical risks as the rhetoric and animosity between US and China ratchets up. Despite this, markets have remained resilient. This perhaps underlines the power of the monetary and fiscal policies that are supporting markets. It also suggests that investors are still putting money to work to buy the dips, having perhaps missed out on some of the strength of the rally since the March lows.
Credit markets have been a key beneficiary of both the policy support and investor buying, and we’ve continued to see spreads tighten further over the last few weeks. We’ve also seen Sovereign bond yields shift upwards a little over this time. We may have expected them to move upwards more sharply as risk assets have recovered, but they have remained fairly steady. This recent move coincided with more positive headlines on the development of a vaccine – perhaps highlighting the potential that better treatments and a vaccine are the routes to a more sustained upward shift in risk assets and bond yields. This may also help a more sustained reversal in value and cyclical stocks over the growth and e-commerce stocks that have done so well.
These recent market moves have given us some re-assurance, so whilst we retain a degree of caution across our portfolios our concerns have not been strong enough to fight against the policy support more meaningfully. The diversification across the portfolios also means that should a vaccine become a more realistic eventuality the portfolios shouldn’t get left behind.
Update posted 16 July 2020:
Markets have recovered sharply since late March when the economic impact of the global pandemic looked bleak. But Government policies across the globe both to tackle the virus outbreak and support economies have been unprecedented in their nature and their size. The massive monetary and fiscal stimulus is epitomised by the US Federal Reserve’s programme to purchase investment grade, and even some high yield, corporate bonds for the first time in its history, along with Congress’s programme to effectively replace the salaries of furloughed workers. With other central banks and governments around the world taking similar measures, risk assets embarked on a major rebound despite extraordinarily bad macroeconomic, consumer and corporate data. With regards the coronavirus itself, in most countries the numbers of new cases and deaths have gradually fallen and the pressure on health services has abated. With progress on a number of treatments that arrest the rapid deterioration of hospitalised patients, governments were in a better position to begin easing their lockdowns.
More recently, as the lockdowns have eased, we’ve seen areas where virus cases have started to tick up once again, particularly in some states in the US, but on a smaller scale here in specific regions of the UK. However, evidence suggests that we’re getting better at protecting the most vulnerable members of society and a return to the extreme control measures of earlier in the year seems unlikely. Accordingly, markets appear to have taken this renewed pick-up in cases in its stride. Naturally, as things gradually return to normal, without completely eradicating the virus, the risks of a full blown ‘second wave’ remains. On the flip side, research into potential vaccines continues with markets bouncing strongly when positive results on drug trials hits the newswires.
Given this backdrop we’ve gradually reduced some of our cash holdings across the portfolios, taking advantage of the volatility where possible. Across the investment profiles, we added to the equity foundation funds around the March lows and subsequently trimmed them back again in mid-June. Whilst the headline equity indices have recovered impressively, particularly the S&P500 Index, the recovery has actually been quite narrow and driven upwards largely by a small number of technology and e-commerce companies whose returns have far outpaced the wider market. From a risk perspective, this can be more worrying as these companies become more dominant in the Index and the risks therefore become more concentrated (particularly in passive index exposures). A key element of our investment approach centres on diversification as we seek to build more all-weather portfolios which are not overly reliant on any particular sectors. As such, we retain some caution across the portfolios. Markets have come a long way, and quickly, and the size of the rally suggests that markets are starting to price in quite an optimistic recovery scenario. Given the continued uncertainty over both the future direction of the virus and the economic fallout, we suspect a period of rangebound or sideways markets is plausible and volatility is likely to remain high.
Update posted 12 May 2020:
Given the continuing uncertainty over both the future direction of the virus and the economic fallout, we believe an element of caution is still warranted on markets at this juncture. We have been engaging with our fund managers extensively during this period to better understand the risks and opportunities going forwards and stand ready to take advantage of future volatility.
Periods of market stress like this highlight the importance of maintaining a diversified investment portfolio. In addition, the current market volatility we are witnessing should create a favourable environment for active fund management.
Original update posted on 18 March 2020:
A reminder about our investment approach
Having been cautious two weeks ago, we have continued to reduce exposure to risk assets across our portfolios. We have increased the cash across many of our funds and taken steps to reduce risk and protect investors’ capital.
However, the current climate is unpredictable and we are keeping an eye on the events unfolding. We are ready to increase risk when the way forward becomes clearer.
Much like our underlying managers, we are constantly reassessing the likely extent of the impact on markets and what outcomes are being priced in. Diversification remains at the heart of our approach. Our portfolios are invested across equities, bonds and alternatives and invested with managers that take different approaches. This diversification means that the impact of any given market shock should be dampened and the portfolios can continue to target a steady positive return over the long term time.
What we expect in the coming months
The long term expectations of the volatility bands of each profile take account of the fact that markets experience periods of heightened volatility such as we are experiencing today. While it is natural to worry about the headlines and it can feel painful to see the value of investments fall, we advise against reacting to short term losses emotionally.
In times like these it’s more important than ever to take a long-term view. Significant market falls are unusual events. Having said that, they are not unprecedented and we have seen time and again that investing in the market over many years bears fruit.
Reminder of the key risks
- The value of an investment, and any income from it, can fall or rise. Investors may not get back the full amount they invest.
- Personal opinions may change and should not be seen as advice or a recommendation.