A fortnightly look at global financial markets by deVere Groups, Senior Investment Strategist Tom Elliott.
- Risk-on sentiment returns in August, cyclically-biased stock markets outperform
- Positive U.S economic data helps stocks but generates doubts over the size of another fiscal stimulus package
- The hunt for yield continues to surprise
- U.S/ China tech wars – the risk of an own goal
- Dividend cuts favour taking a global approach to investing
- A difficult autumn ahead for U.K Chancellor Rishi Sunak
- Weak sterling?
Market sentiment: Global stock markets have made solid gains so far in August, helped by positive economic data from the U.S. This is despite renewed waves of Covid-19 leading to fresh lockdowns around the world. Recent trading sessions have seen a return of volatility, particularly for the U.K market, but fiscal and monetary policies remain supportive, worldwide, and these help underpin the recovery in risk assets seen since their March lows.
Market themes. Japanese stocks have led the rally in recent weeks, followed by continental Europe. This reflects a rotation of investor interest, from growth stocks (eg, technology) into more economically-sensitive cyclical stocks. However, the more modest gains of the U.S stock market over the same period have still enabled the NASADAQ to record a new high, and the S+P500 has seen a new intra-day high. Refreshingly, the U.K stock market has shared in the August rally, as have global small cap stocks.
Modest returns from some of the larger emerging markets (eg, China and South Africa) have limited the overall contribution of EM equity to investors’ returns so far this month. Investors are perhaps pausing for breath, after three months of outperformance against developed word stock markets. Sentiment towards Chinese stocks has been affected by President Trump’s recent onslaught against the owners of the Tick Tock and We Chat apps.
Meanwhile fixed income markets remain steady, with the yield on U.K gilts, for example, still negative out to 5 year maturities. The U.S 10 year Treasury yield has climbed from a record low of 0.5% earlier in August, to 0.7%, after a stronger than expected rise in U.S July inflation. A further sign of the U.S economic recovery came in yesterday’s weekly new unemployment claims, which were below one million for the first time in seven months.
The hunt for yield continues to surprise. In the current world of cheap money we are continually faced with ‘that can’t be true!’ stories, that are indeed true. The latest is from the U.S high yield market, an asset class formerly known as ‘junk bonds’. Ball Corporation -an aluminium can manufacturer- has borrowed $1.3bn from investors for 10 years, at a rate of 2.875%. By way of comparison, the U.S 10 year Treasury -regarded by many as the safest possible financial asset- yielded the same amount as recently as late 2018. The ‘hunt for yield’ is taking investors into higher risk assets that many would not have held before.
Gold is down 5% since peaking at a new high of $2,069 on 6th August. As U.S inflation increases, the negative real interest rate on dollar cash increases, making gold more attractive.
U.S economic data. This week’s reported rise in U.S inflation, with core CPI up 1.6% in July over the previous 12 months (compared to 1.2% in June), has added to the perception that the U.S economy is enjoying a broad-based recovery, despite large pockets of renewed lockdowns. It is supported by several weeks of generally good employment data. This makes it easier for Republicans in Congress to bat away the Democrats demand for a $3 trillion fiscal stimulus, that would include extending furlough pay to January, and to offer a compromise at $1 trillion. There may be an element of genuine fiscal conservatism that motivates Republicans (though recent Democrat presidents have shown more of that than Presidents Bush and Trump). But with only a few months to go before the Presidential and Congressional elections, the size and the nature of any new stimulus will more likely be made on purely political calculations.
U.S/ China tech war. It is unclear to what extent President Trump’s recent verbal onslaught against Chinese tech companies is a pre-election gambit that investors can afford to sit through, or a fundamental change in long-term U.S policy that will ultimately lead to two rival tech spaces in the world.
Pragmatism would suggest the former: U.S tech companies sell a lot to China, with China accounting for 25% to 35% of sales made by Nvidia, Texas Instruments, Qualcomm, Intel and Broadcom. Apple assembles its products in China, and the country (including Taiwan) accounts for 20% of its world-wide sales. If Trump orders Google’s Android and Apple to stop allowing the highly popular Tenant’s We Chat app to be downloaded on their mobile devices, sales by those companies in China could plunge. Furthermore, some analysts argue that cutting Chinese tech companies from U.S suppliers will be counter-productive. It will hasten the emergence of top-class chip manufacturers in China, financed with cheap government credit, that go on to compete globally against U.S companies.
But national security considerations, and a sense of foul play regarding trading rules, may yet win out. The U.S feels that China has had a free hand for too long in the U.S market, able to buy U.S tech companies and use their growing share of consumer electronics and associated software to hollow out U.S technological superiority and for espionage purposes. And for all China’s talk of upholding trade and globalisation, it is accused by the west of flouting WHO rules by having an unlevel playing field in its home market, in tech and other sectors.
Dividends. If ever a U.K-orientated investor needed reminding that a diversified portfolio of assets is safer than focusing on their home market, it has been the FTSE 100’s underperformance in 2020. Large dividend paying companies in the index have slashed their pay-outs in response to weak demand, weak commodity prices, and in some cases on government insistence. A similar, but much less severe, theme is being played out in other countries.
But, as the asset manager Janus Henderson has recently reported, the severity of dividend cuts is less abroad. It estimates a drop of between 19%, and a worst case scenario of 25%, for cuts in global dividends. But the worst case scenario for the U.K is a 42% drop, reflecting the large share of high dividend payers. This goes some way to explain the underperformance of the U.K stock market this year. It has few large tech companies, and many in currently unloved sectors where we are seeing dividend cuts.
A difficult autumn ahead for UK chancellor Rishi Sunak. September sees a resumption of U.K/ E.U trade talks, with tensions running high over fishing rights, ‘level playing field’ commitments, the role of the ECJ in policing any agreement and -separate from the trade talks- continued uncertainty over the customs status of Northern Ireland. The deadline is the end of December. Positions are so entrenched on both sides that talks look likely to go up to the end of the year deadline. A recent news report suggested leading members of the Conservative party are urging Prime Minister Boris Johnson to tear up the legally-binding December 2019 Withdrawal Agreement. There is a real risk of a no-deal exit from the E.U’s trading arrangements. There will be pressure on the government to prepare resources for such an eventuality, particularly in relation to easing congestion at ports.
At the same time the government will be bracing itself for further waves of Covid-19, as cooler weather drives people indoors to socialise. A severe second wave would require another large step-up in public borrowing, to fund social welfare (such as a fresh furlough scheme), and to build up further capacity in the health system and commit to maintaining it into 2021.
Meanwhile, in October the existing furlough wage scheme is due to end, with some economists warning of a sharp rise in unemployment.
So while Chancellor Rishi Sunak is preparing his October budget, in which he has promised to outline how the country will tackle the ballooning budget deficit (18% of GDP, from 4% in February), fresh calls may well be made on the purse strings. Fortunately for Mr Sunak, investors are still eager to buy U.K government debt (gilts), and the Bank of England is helping with its £745bn purchase programme. But he will be wanting to demonstrate resolve in raising taxes sooner rather than later, in case the bond market turns against the government. Some difficult choices lie ahead.
Sadly for the U.K, one reason for its relatively poor economic performance this year, compared to other industrialised countries, is its reliance on the consumer-facing service sectors for growth. Retail, hospitality and transport have been key drivers of employment growth.in recent years. They have all been hit hard by the pandemic, as this week’s second quarter U.K GDP figures demonstrated: -20.4% compared to the same period last year. This compares to -11.6% for Germany, and -9.5% for the U.S.
Weak sterling? A potential no-deal Brexit and a relatively weak economic recovery both suggest sterling could weaken over the autumn months.