Macro update: August 2020
Our 4 phase framework forecasts markets are in an uncertain environment
Welcome to our monthly macro update, giving greater insight into our outlook for investment markets and the investment ideas that currently interest us. We are well known for our agile approach to investing assets, and in these current volatile conditions, this is incredibly important.
We make our internal views more accessible using our four-phase framework, the FOURcast. Much like a weather forecast, it provides a guide to what we think may be coming, and how we should position portfolios to prepare for the climate to come.
- Equity markets rose this month. Corporate credit spreads reduced further causing these bonds to rise in value. Significant stimulus continued to provide an important tailwind to business sentiment, even as the reopening of some economies stumbled.
- The weakness of the US dollar, negative real interest rates and economic uncertainty led to a surge in the price of gold and other precious metals.
- The EU approved a historic €750bn recovery fund to tackle the current downturn. US lawmakers debated the size and scope of their next stimulus package, as both parties agree on the need for additional spending.
- Cases of COVID-19 continued to rise in the US, with several governors reintroducing measures to slow the spread of the virus.
US and Asian equities rose over 5%, with emerging markets performing strongly. European and UK equities lagged, with most markets finishing the month flat to slightly down.
Economic expectations are modestly positive over the medium term, credit conditions are improving, but valuations are expensive. Our view remains that we are in the Downturn phase, but we recognise that there is meaningful support for risk assets. The reopening of economies coupled with ultra-loose monetary and fiscal policy is providing a major tailwind for equity and credit prices. But the recovery is fragile and unpredictable, and the threat of a second wave is ever-present. We continue to prefer high-quality assets and areas of the market strongly supported by policy actions.
- Economic conditions continue to improve and look positive on a 12-18-month basis. Given the severe drop in economic activity earlier this year and the scale of stimulus measures in response, it is reasonable to believe we have passed the trough. The inflow of recent positive economic data supports this. But the risk of a second global shut down poses a major threat, and we believe the longer-term economic recovery priced into markets may be optimistic.
- Credit conditions continued to improve over the month. High-yield corporate credit spreads reduced considerably, reflecting meaningful central bank support for bond markets. Despite recent defaults, policy action to improve borrowing conditions has been a success.
- Valuations continued to rise in July. Whilst high valuations should not be considered in isolation, and in many markets are being driven by companies less prone to economic uncertainty, we are seeing overvaluation on an economically adjusted basis.
INVESTORS LOOK TO GOLD AS AN ALTERNATIVE STORE OF VALUE
The US dollar slid to a 2-year low, as US coronavirus cases continued to increase and monetary policy remained loose. The Federal Reserve (“the Fed”) signalled it will keep interest rates near zero for the foreseeable future, causing real yields on many US government bonds to tumble further into negative territory. US lawmakers debated a $1 trillion coronavirus relief bill proposed by Senate Republicans. The accommodative stance of the Fed and a political divide about the size and scope of the next stimulus package put pressure on the US dollar.
Dollar weakness, economic uncertainty and loose monetary policy led to a surge in gold prices, which rose 11% this month to all-time highs. Silver and other precious metal prices also rose.
EU RECOVERY FUND
EU leaders agreed this month on a €750bn ($860bn) stimulus package to fight the biggest recession in its history. The recovery fund comprises €390bn of grants and €360bn of low-interest loans. The emergency funds are vital to the economic recovery of those economies hit most by the pandemic. Most importantly, the recovery fund will take Europe another step towards further integration. This is something that could not be achieved during the European Sovereign Debt Crisis of 2012/13 and is seen as significant progress by market participants.
The number of new coronavirus infections continued to rise in the US, reaching new highs during July. The virus is also spreading across emerging economies, such as Brazil and India, at an alarming rate. Metropolitan centres across Asia, such as Tokyo, Hong Kong and Melbourne are seeing record infections. European countries, which were largely successful in containing the virus, are now starting to see infections rise, driven by local spikes, as lockdown measures were eased. The UK introduced a 14-day quarantine on everyone arriving from Spain; Belgium tightened restrictions amid fears of a second wave.
This serves as a reminder that reopening can come to a halt anytime if the epidemiological threat grows. The economic recovery remains in danger of stalling.
“Our view remains that we are in the Downturn phase, but we recognise that there is meaningful support for risk assets.”
IMPLICATIONS FOR PORTFOLIOS
With economic expectations showing signs of improvement, albeit unevenly and off a low base, we are continuing to see selective opportunities in return-seeking markets. Within equity and credit, we advocate a skew to high quality companies, with features such as strong balance sheets and high interest coverage, that are better positioned to weather the current crisis.
We also favour areas of the market supported by policy actions, including selective corporate credit, and precious metals, which should continue to benefit from excess liquidity and low real interest rates.
Recognising continued economic uncertainty as countries attempt to reopen their economies, we also believe structured equity can play an important role in portfolios, protecting from market falls whilst accessing equity market upside.
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