A fortnightly look at global financial markets by deVere Groups Senior Investment Strategist Tom Elliott
- Investors are pricing in a U-shape recovery
- The ability to test for covid-19 will partly determine how and when lockdowns end
- Tech and healthcare – having a ‘good’ crisis
- Is all this money inflationary?
- Multi-asset investing for times of uncertainty
- Will a post covid-19 mini-boom be used a fig leaf for a hard Brexit in December?
Market sentiment: Consolidating. Having recovered from their crisis lows of a month ago, global stock markets are treading water as investors wait for more clarity on corporate earnings forecasts. The strength of corporate earnings over the coming 12 months will depend on how, and when, countries’ lockdowns end, and whether the substantial fiscal and monetary policy responses from governments and central banks prove sufficient to enable a quick return to normal economic life. In view of these policy responses (which now include the previously unthinkable purchase of junk bonds by the Fed and the ECB), it seems reasonable to expect a rebound in both growth and corporate earnings from the third quarter, as lockdowns are lifted. This would constitute a U-shape scenario in the alphabet soup of possible scenarios being discussed by economists.
Since stocks are priced on their future earnings potential, not just on one year’s earnings, current share prices appear reasonable if a U-shape scenario does unfold. And if an unwinding of lockdowns over the summer can be done without provoking a second wave of illness, we can expect a further rally for risk assets. Worse-case scenarios (such as the L-shape) will be steadily discarded, market volatility will decrease, and investors become more confident.
Tech and healthcare. The outperformance of tech and healthcare stocks continues. Previous bear markets that often saw growth stocks underperform the main market, as investors shied away from riskier parts of the stock market. Today anything that offers its services primarily through the internet, and is not reliant on advertising, is considered a relatively safe stock in the near term. Longer term, it appears likely that many habits learnt by us -as consumers and workers- during lockdowns will stick, to the benefit of the tech sector. Zoom’s video calling and Microsoft’s Teams are good example. I rarely used them before, now I using them constantly.
In healthcare, some companies are benefiting from demand for their products as the virus claims more victims and hospitals fill up. But the real story is the longer term impact of the crisis on the industry, which can expect to be given greater government protection amid claims it is a strategic asset. More localised production of key items and pharmaceutical ingredients may push up production costs for the industry, but in return for on-shoring their supply chains companies may be given protection from overseas competition, and be allowed to raise prices to more than compensate.
Near term, it’s all about testing. Long term, we need a vaccine against covid-19 in order to be certain that it is conquered. The earliest estimate -if current trials are successful- is for the production of a vaccine to begin next summer. But lockdowns can be ended with some confidence if testing for antibodies is expanded. Individuals can go to work in the knowledge they have had exposure, and acquired immunity, and are not currently contagious. National levels can be established, to determine if/when herd immunity has been achieved. The shape of the global economy in 2020, and ultimately the outlook for corporate earnings this year, may be determined by the availability of testing kits.
Longer term, should we fear inflation? The jury is out -and will remain so until lockdowns end- as to whether the global economy will see a wave of inflation, deflation, or perhaps neither. After an initial inflationary boom, caused by pent-up demand and supply bottlenecks, ‘neither’ looks a surprisingly probable option.
At first glance the inflation-worriers have a lot of good points. Governments are borrowing money at spectacular speed, in the past this has fuelled boom economies and inflation. Central banks are promising to buy the government debt to ensure demand, and to keep borrowing costs stay artificially low. The ECB will inject EUR 750bn of cash into the eurozone economy, by buying bonds, through its Pandemic Emergency Purchase Program (PEPP). The Fed is promising literally unlimited bond purchases. The Bank of England has broken a central bank taboo, and will start buying bonds directly from the government. This so-called ‘monetary financing’ of government spending has been seen previously in the Weimar Republic, Zimbabwe and Venezuela.
Surely, the inflation worriers argue, this money has to go somewhere and will raise prices? The same worries were raised when asset purchase programs were introduced in the wake of the 2008 financial crisis, and yet inflation proved an illusory worry. Importantly, money is killed when it is used to repay bank loans. And much of the new central bank money being created will be used to do that, whether its governments, businesses or households paying off the large debts that are likely to amass over the coming months.
An additional source of deflationary pressure comes from China. The countries huge manufacturing capacity, and increasing automation globally, have pushed down the cost of ‘stuff’ globally, along with wages in mature industrialised economy. These factors, along with weaker demographics (older populations in wealthy countries spend less), may continue to neutralise the money creation that is currently taking place.
Multi-asset investing. Stocks perform best with mild inflation. Real assets, being physical assets with an actual use, use such as commodities and real estate, shine most during high inflation. Deflation is often accompanied by economic recession and risk aversion, which government bonds enjoy. All of these can be found in most multi-asset funds. The uncertainties over how covid-19 will affect savers fully justifies a multi-asset approach to investing. The expected returns, relative to the risk taken (ie, volatility), can easily better a portfolio made up entirely of stocks or bonds.
Brexit and sterling. If we see a surge in U.K growth in the second half of the year, from pent-up demand and continued loose fiscal and monetary policy, the government may decide that the near-term economic cost of leaving the E.U on 31st September without a deal is worth taking, because any economic fallout will be hidden within noisy economic data. Currency investors, however, are likely to be looking ahead and will factor in the likely medium and long term hits to GDP growth and tax revenues, compared with leaving with a free trade deal in place with the E.U. They may prove unforgiving, especially if a post-crisis mini-boom results in a widening trade and current account deficit.