Multi-Asset market review

July 2020

The summer tends to be a quieter season in markets for obvious reasons and while this year is hardly a normal holiday period, July was fairly flat before a jittery final few days as the US economy posted its worst quarterly contraction since the 1940s.

For now, the equilibrium between Covid damage and the 2020 version of central bank and government puts continues to hold, and the US Federal Reserve showed it is firmly in whatever it takes territory at its July meeting. Chair Jay Powell said the path forward for the economy remains extraordinarily uncertain’ as a spike in Covid cases looks to have deflated any initial recovery and interest rates will remain near zero for as long as necessary while labour markets struggle back towards ‘normality’. Early predictions said rate lift-off in the US may be as far in the future as 2024.

There remains an obvious disconnect between economies and stock markets as the latter have broadly continued to ignore bad news and clawed back further ground from the bear market collapse in March. The divide between Wall Street and Main Street has rarely been as wide and this should be enough to give investors pause for thought.

For us, the simple fact is that the length and severity of this pandemic, as well as its ultimate repercussions, are still unknown, particularly with signs of a second wave or, in the US, a continued acceleration of the first. We are still keen to dial up risk in our portfolios within our predetermined parameters, but after taking the first steps in June, we are reluctant to be more aggressive at such a clear ‘wait and see’ time.

Markets are currently digesting an understandably weaker earnings season and while the US might nominally seem in better shape having coming out of lockdown early, the country’s daily new cases figures were back on a rising trend across many states at the end of July. Given how reluctant Donald Trump is to say anything negative at least about the state of the country under his leadership his recent comments that the virus will get worse before it gets better was enough to shake markets out of their summer lull. Meanwhile, news that UK visitors to Spain will face a two-week quarantine also pulled equities down towards the end of the month, with travel companies suffering a renewed pummelling.

Highlighting growing concerns about recovery and how winter might look with no vaccine in sight, gold’s recent ascent would not have surprised seasoned market watchers, with the metal hitting an all-time high and up more than 25% so far in 2020.

In the UK, GDP actually grew 1.8% in May but remains around 25% down on the pre-Covid February level (in comparison, the UK economy fell 7% during the global financial crisis and took 41 months to recover). To put the economic hole in perspective, the UK must somehow engineer GDP growth of more than a third just to get back to where we were and, for anyone with the energy to contemplate this, it comes against a backdrop of reports that the UK and EU will struggle to sign a post-Brexit deal.

In recent weeks, EU chief negotiator Michel Barnier said any deal looks unlikely given the UK position on fishing rights and post-Brexit competition rules. The UK has ruled out extending the December deadline and we move on to another round of talks scheduled for mid-August in Brussels.

While equities have continued to recover, it is worth looking in more detail, particularly when it comes to the US. The S&P 500 is already close to its pre-crisis peak but the contribution from just a few technology names is huge, and the six largest drivers - Facebook, Apple, Alphabet, Amazon, Netflix and Microsoft - are trading at a premium to March levels. By contrast, the remainder of the index is still below pre-Covid highs, a position matched by other global equities.

For us, there are growing reminders of the top of the last tech bubble in 1999-20: Apple, Microsoft, Amazon, Facebook, Alphabet and Tesla, for example, now account for almost half of the Nasdaq, and the four biggest US tech companies are larger than the entire Japanese stock market.

Despite these stats, and there are many others, we should pause to highlight a key difference with the situation in the TMT bubble, namely that many tech stocks do now have revenues that can, at least partly, explain their valuations. Technophiles point to such supportive data, with EPS growth estimates for tech flat for this year and at 16% for 2021 versus the rest of the S&P with respective figures of -36% and -9%.

But while all this is true, we go back to the old proverb that trees cannot grow to the sky. In June as a possible first sign of this Netflix warned that its pandemic-related growth spurt would slow over the second half of the year, having added 10 million subscribers in a lockdown-dominated second quarter. Netflix expects to add only 2.5 million subscribers in Q3, which would be its weakest showing in years, and this was enough to make a dent in the company’s considerable share price growth in recent weeks.

RWC’s John Teahan (whose Enhanced Income Fund is held in our Income portfolios) posted a great piece on the tech question, examining it through the lens of Amazon a stock that encapsulates the sector’s influence on market returns. As a value advocate, it is little surprise to find Teahan concluding he would rather watch Amazon from the sidelines as more and more headwinds emerge.

From growing competition to political challenges from right and left, we see a range of factors that could potentially uproot (or at least introduce a mild fungal blight, for all you dendrophiles out there) these fast-rising growth trees. Faced with all this, we are content to remain underweight an increasingly expensive part of the world.

As we move through the summer, attention is turning to the US Presidential Election, with Trump requiring a swift economic recovery and further stock market gains to maintain his stay in the White House. The Democratic campaign is gathering momentum and if Joe Biden takes a decisive lead in the polls, we may see Trump move into stop at nothing territory, potentially reversing corporate tax cuts for example. He has already mooted delaying the election to avoid any chance of ‘fraud’ from mailed in votes, which would take an act of Congress to implement.

An ongoing re-escalation of trade tensions is a real possibility if the President concludes his best chance of re-election is nationalism and China bashing and we expect to see more references to the ‘invisible Chinese virus’ picking up. Signs of this have begun, with tit-for-tat consulate closures: after the US shut the Chinese Consulate in Houston on ‘spying’ fears, China closed the US Consulate in Chengdu. A second stage of the trade deal announced late last year seems increasingly unlikely in such a febrile atmosphere.

Just to add a little further spice to this bubbling US political stew, Kanye West threw his hat into the presidential ring in July, with his ‘Birthday Party’ apparently running on a pledge that everyone who has a baby gets a million dollars. There remains uncertainty over whether this is a publicity stunt for a new album and, more importantly, concerns about his health but in a world where the actual President advised injecting bleach as a cure for Covid-19 (and, incidentally, has also refused to confirm he would accept the result of an election should he lose), we remain firmly through the looking glass.

While there are obvious reasons for concern in the shorter term, we would highlight signs of light looking further out. Global interest rates are set to remain lower for longer as inflation remains muted for now, which favours equities, and we feel the first embers of a new bull market are kindling. There are encouraging albeit early signs of new leadership and long-term trends (particularly the small-cap premium) starting to emerge.

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Friday, August 7, 2020, 1:55 PM