As we edge towards the end of the most highly anticipated earnings season since the Great Financial Crisis, volatility and daily traded volumes have remained low, as is often the case with investment markets during the summer months.
Looking back at our 2020 Investment Outlook from the New-Year feels somewhat surreal given the events that have unfolded in the meantime. While it was impossible in late December of last year to forecast a pandemic of this magnitude and all that came with it, we feel at Seaspray that most of our forecasts for markets were in fact quite accurate. Although in many ways it was a different world back in January, as it happens many things actually panned out as we had anticipated, albeit somewhat accelerated by the outbreak of Covid-19 and its rapid advancement around the globe.
At the start of the year, we outlined our “very bullish” view on gold and that the precious metal was “at the beginning of a secular bull market”. We saw the potential for Geopolitical risks and tensions to propel gold higher throughout 2020, while also acknowledging that one third of global bond markets were carrying a negative yield at the time and that investors were in great need of a ‘safe-haven’ aspect to their respective portfolios. We alluded to the fact that gold has a distinct inverse correlation to real interest rates, and despite central banks remaining in ‘pause’ mode at the start of the year, with no Federal Reserve rate cuts priced into markets at the time, we forecasted that the Fed would cut this year and that “global central banks will be forced to ease despite the Fed’s plan for 2020 to hold rates where they are”.
While we recognize that many of these events played out a lot faster than we initially anticipated as result of the outbreak, we still feel that our expectations for the year were accurate. Gold has gained over 30% since our 2020 Investment Outlook was released in January, rallying from $1,520 on New-Years Day to an August peak of $2,078. We have been and continue to be positioned accordingly.
In line with central bank interest rates, we expected sovereign bond yields to fall throughout 2020, forecasting that US 10-year Treasury Note’s would gravitate towards where the 10-year UK Gilt was trading at the time, at a yield of 0.85%. As Covid-19 brought increased volatility to all asset classes in late February, bond yields tumbled and US Treasuries reached our target much quicker than was forecast, with the benchmark 10-year having since stabilised and currently trading at a yield of 0.7%.
In terms of equity markets, nobody could have foreseen what turned out to be the fastest drop into a bear market from an all-time high ever, followed by an almost 5-month fiscal and monetary stimulus-fuelled rally with some indices even returning to positive territory for the year-to-date. While we saw volatility of that nature as unlikely, we did expect an increase in equity volatility in 2020; especially in the latter half, with most of our focus on November’s US General Election. We reiterate this expectation for some heightened volatility around the Election and are positioning appropriately with regard to our direct equity exposure.
With regard to the currency space, we would also like to take a look at our guidance from the start of the year. In January, we had a relatively strong in-house view that at the time we were in the latter stages of the US Dollar bull run. We believed in our forecast for central bank easing across the board this year, especially by the Fed who in January had their interest rate set at a range of 1.50% – 1.75% and had some room to go lower. This, in our view, would in part drive the Dollar lower and end the tight upwards slanted channel that the currency was trading in for most of 2018 and all of 2019. While we expected lower volatility across currencies, we believed that EUR/USD would strengthen from 1.12 at the time, to circa 1.15 by year end. Similar to other assets, as a result of the pandemic-related volatility, the pair reached our target much faster than we anticipated and is currently trading just below 1.18. We had a price target of 94.50 on the Dollar Index (DXY), and while there was an initial spike higher in the world’s reserve currency in March when risk-assets were in sell-off mode, the greenback has since reached our January price target of 94.50 last month and has continued its fall into late July and early August.
As we currently see it, a weakening US dollar should persist in the short to medium term, particularly in the EUR/USD currency pair. Faster European growth, better virus control, and the recent establishment of the EU recovery fund has helped reduce tail risk and balanced the global currency opportunity set. That said, the dollar is weak most likely because the Federal Reserve is printing huge quantities of it out of thin air. But so, too, are other central banks. It is simply that the US is doing it more liberally.
We maintain our current asset allocation, which favours equities and credit over sovereign debt and cash.
We must reiterate that we do not own the broad market, we own a heavily researched group of stocks that we have conviction in for the long term. Amid our cautiously optimistic bias, we believe at Seaspray that opportunities are continuously presenting themselves within specific asset classes in all market environments.
For existing long-term investors, in well diversified multi asset and multi manager portfolios our core advice remains : Wash your hands, social distance and stay invested. We will advise you if changes are needed and where potential opportunities may present as we move through H2 2020.
Key risks to the recovery are present and we remain alert to the potential for further downside. Our positive longer-term structural view towards equities persists, but if excessive optimism is evident in the markets’ price action we may look to rebalance our portfolios in terms of cyclical and defensive stocks weightings on a short term, tactical basis. In addition, we are mindful of the risks of a slower economic rebound or a second wave of the virus, both of which would dent the current narrative dominant in the market. Flexibility and an active approach remain essential.
Our geographical preferences are a function of both our views on localised growth prospects, valuations, and the sectoral makeup of the stock market. Currently, we favour Eurozone over North America. Whether the vantage point is the economy, the political landscape or Covid-19, Europe appears to be in better shape than the US. Which is why we retain an overweight position in European stocks. EU member states’ endorsement of the Franco-German led €750 billion recovery fund last month and the ECB’s continued monetary stimulus put the European economy on a much firmer footing. US stocks are already very expensive in any case. For US equities to maintain their current price-earnings multiple of around 24, corporate profit margins would have to remain stable. That is a stretch, particularly when factoring in the US’s continued failure to contain Covid-19, the growing regulatory backlash against Silicon Valley and uncertainty surrounding the outcome of the November Presidential election. Mindful of these risks, we remain neutral US stocks for now. Our US equity exposure is a small underweight on an overall basis, however we continue to have strong conviction across specific sectors within the US market.
As the months tick on, we continue to have one eye on the US November Election. The election itself is currently three months away, an eternity in political time. As it stands, polls point to a likelihood that Joe Biden defeats Donald Trump for the presidency which probably means a less business-friendly regime for the next four years. All of which argues against what is already an overvalued currency. Still, there are some key trends to note now:
- A positive 3-month equity return prior to the election has been highly favourable to the incumbent party, predicting 20 of 23 elections since 1928.
- No president has been re-elected after a recession in the last two years of his term except Calvin Coolidge who inherited it.
- President Trump’s enthusiasm numbers among his supporters are still high, though polls and approvals have dipped, suggesting it will be a race to the end.
While still looking at the US, aside from the election we still see a few potential risks which could muddle the US equity landscape ahead including de-globalization’s impact on its labour margins, aging demographics, and a shifting index composition.
We remain overweight gold, which continues to be the most attractive defensive asset given the inflation risks that have come with the vast flows of central bank liquidity worldwide, our expectations for a further weakened dollar, increased geopolitical risks and the additional uncertainty of how the Covid-19 pandemic might play out during the second half of the year – all of which are supportive of further gains for gold. As we write, the precious metal has pulled back off last week’s highs and now sits just below the $1,950 mark. As investors on all time frames take profit, after what has been an impressive run for gold over recent weeks, pullbacks were inevitable and we must remind clients; no market ever travels in a straight line. From a technical standpoint, a pullback in gold to $1,900 is not only conceivable but is beginning to look more likely. If we got a scenario whereby we saw another sharp sell-off in equity markets, profit-taking may occur in gold markets on a very large scale which could potentially bring us back towards the $1,800 mark briefly. This is not our base case scenario but is a possibility and would present us with favourable entry points in gold from a longer-term perspective.
So… Q3 so far…….
Over the last 6 weeks we have seen vaccine news, updates from central banks and Government leaders, some extremely volatile Q2 economic data and earnings results, and finally an increasingly concerning tension between the world’s two largest economies; the United States and China.
Risk assets took a bid at different stages in July as news continued to break that pharmaceutical groups including AstraZeneca, Pfizer & BioNtech, and Moderna had all commenced next stage trials of their potential vaccines for this coronavirus, which helped somewhat to offset signs of a resurgence of cases on a global basis throughout the month. Additionally, there are 271 treatment and 198 vaccine candidates at present.
We saw the Fed Chair Jerome Powell reiterate the dovish stance of the Federal Reserve and confirm that the central bank is further committed to low interest rates for the foreseeable future. However, he also emphasised the role that fiscal policy can play in aiding the economic recovery. Negotiations on further stimulus continues between Democrats and Republicans in Congress and represents a potential issue for US equities in the short to medium term.
The announcement of the €750 billion EU stimulus plan was an important milestone for the bloc. This agreement came after almost 5 days of intense negotiations, in which we saw threats of a French walkout and a Hungarian veto, along with strong opposition from the ‘frugal four’. Encouragingly, 70% of this fund is expected to be spent over the next two years. The European Commission can now raise funds to distribute to members, in a mixture of grants and loans. The grants aspect of the package, coming in at €390 billion, was smaller than the initially proposed €500 billion following canvassing from the aforementioned frugal four nations led by Dutch PM Mark Rutte. EU leaders during this time were also able to agree on the bloc’s €1.1 trillion 2021 – 2027 budget, a cause of debate even before the virus reached the continent. The way we see it, a full economic recovery can only take place if rising activity does not also lead to rising infections. Governments should therefore continue supporting consumer incomes and businesses until a vaccine is available or until the virus is brought under control by other means. The extent to which they do so will be key to the outlook from here.
In the final few days of July we saw record falls in GDP on both sides of the Atlantic grabbing headlines, with the US economy contracting at an annualised rate of 32.9%, which while ahead of estimates for a decline of 35%, still represented the weakest reading since the 1940’s while in Germany a contraction of 10.1% was worse than expectations for -8.9% and was the weakest reading in almost 50 years. It was a similar story for the eurozone as a whole which saw a contraction of 12.1% for the second quarter compared to estimates for -11.2%. Spain, France, and Italy saw declines of -18.5%, -13.8%, and -12.4% respectively. This week we saw the UK’s second quarter GDP release, coming in at -20.4% broadly in line with expectations. This was the UK’s biggest quarterly GDP drop since records began in 1955 and is the worst slump out of any European country for the three-month period up to June 30th. The sharp falls in GDP were expected and most business surveys now indicate that activity has rebounded sharply as each month passes and we leave March and April behind us. While these quarterly results were backward looking in nature, they were still significant enough to concern markets.
Strong second quarter results from US tech giants Alphabet, Amazon, Apple, and Facebook helped lift markets towards the end of July. So far for Q2 earnings, over three quarters of S&P 500 companies have beaten analysts’ earnings estimates. This still leaves Q2 earnings more than a third below Q2 2019, marking the largest year-over-year decline since the financial crisis in 2008, but full-year estimates are rising again. On the other hand, earnings ‘misses’ in energy and materials were punished, with the sector dispersion we have seen in equity markets so far this year continuing throughout this earnings season. The good news: overall things weren’t as bad as Wall Street analysts had feared, which was a 44% earnings drawdown in the States.
As we have highlighted on a number of occasions previously, we remain concerned about the potential for a serious escalation in US-China tensions, and these concerns were increased further last week after President Trump issued an executive order banning transactions with Chinese apps TikTok and WeChat, giving US groups 45 days to stop dealing with them. The timing of this move is significant as it comes just ahead of next week’s meeting of trade representatives from both countries to review the compliance by China to the terms of the Phase 1 Trade Deal. The White House also delivered recommendations that all Chinese firms who are currently listed on US stock exchanges be de-listed unless they provide US regulators with direct access to their audited accounts. This advancement in the tensions comes soon after the Trump Administration ordered China to depart its consulate in Houston, Texas which came as a retaliation to similar orders from China regarding the US consulate in Chengdu.
With tensions already strained over issues such as Hong Kong and US accusations against China over the source of the coronavirus, the meeting next week has the potential to further diminish relationships. Equally, the Chinese response to the move against TikTok and We Chat could result in a technology war with companies such as Apple and Microsoft seen as potential targets for any retaliation. Watch this space.
As a final note, we would like to add that investors should consider the risk of a successful coronavirus vaccine, which could potentially come at any stage over the next 6 or 12 months, unsettling markets by sparking a sell-off in bonds and rotation out of technology into cyclical stocks. Tech stocks make up significant portions of many equity indices, namely the NASDAQ 100 and S&P 500, and could temporarily drag these markets lower if and when the vaccine is first announced. In contrast, we will likely see a sharp rally in more cyclical stocks, particularly in sectors and industries such as consumer discretionary, airlines, hospitality and services, and general tourism.
With all of the above in mind, we must also continuously monitor the ongoing and growing investor demand for Environmental, Social and Governance (ESG) structured products and funds. At Seaspray we have seen a strong uptick in ESG investing throughout the first half of 2020 and similarly into July and August. The Covid-19 pandemic worldwide and Black Lives Matter movement in the States both seem to have had a significant impact on everyday life, raising social awareness. Regarding ESG, investors are increasingly applying these non-financial factors as part of the process to identify growth opportunities and material risks. We do not see this demand going away any time soon and believe that traditional risk-return equations will likely be rewritten in some form to include ESG factors over the coming years.
Global equity funds from April to July have seen four of the best eight months on record for fund inflows, with investors committing the equivalent of $4 billion in new capital to the category. $790 million of this was in July alone. The skew towards growth stocks partly explains the inflows to global funds. But it is in fact the popularity of ESG funds that gives a real clue as to why global equity funds are getting such a boost. ESG funds are overwhelmingly global in nature. Investor preference for ESG has therefore boosted the overall inflows to the global fund category significantly. Over the last year, one third of the money flowing into global funds has been committed to those focused on ESG investments; in June and July, this proportion rose to more than half (July ESG global inflow was $420m v regular global fund inflow of $375m).
If you would like to discuss anything raised above or would like a review of your financial position, please do not hesitate to contact us.
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