The Multi-Asset Process

May 2020 Market Review

As we near the midway point of 2020 and come through a second month in lockdown, it remains difficult to look forward, literally or figuratively, to what surprises the rest of this year and beyond might have in store.

Stock markets, in their role of giant discounting machines, appear to have no such trouble, however, and just two months after one of the fastest and deepest bear markets in history, many indices have already retraced a large portion of their losses.

Bad news is never welcome but given the domination of Covid-19, it was at least novel to see another factor behind a dip in markets later in the month, with China’s plans to introduce national security laws in Hong Kong sparking fears of further (presumably socially distanced) pro-democracy rallies. The US saw its own rallies towards the end of the month and the country is facing a toxic combination of pandemic, economic depression and race riots with perhaps the most divisive election ever just a few months away.

Something else to watch out for is a potential resumption of trade war rhetoric, spiced up – for the more conspiracy-minded out there (which, worryingly, seems to include the US president) ­– with a new Coronavirus impetus. Concerns of a new cold war have been growing as China has pushed back against accusations around ‘the Chinese virus’ (as per President Trump, to be clear) and tensions continued to rise ahead of the National People’s Congress meeting at the end of May.

We also saw the US Senate overwhelmingly approve legislation that could mean Chinese companies such as Alibaba and Baidu are barred from listing on American stock exchanges. Meanwhile, as Boris Johnson desperately tries to deflect the public gaze from his chief adviser’s eyesight and driving habits, there is growing talk the UK will ban Huawei from the 5G network.

Given the Sino-US relationship is a key part of both the Trump and Biden presidential campaigns, this has to be a major area of focus in the months ahead. We can only hope they heed political strategist James Carville’s comments about what remains a key electoral factor – and focus on the economy part rather than the stupid.

When asked for outlook comments, I am tempted to echo the answer Lindsell Train UK Equity manager Nick Train gave us during our recent half-yearly review of underlying funds. Asked about the possible impact of stimulus packages from governments and central banks, Train said “I just don’t know” – although we should qualify this by stressing he is a stock picker looking for world-class companies that grow over the long term whatever the macro backdrop.

While I have a lot of sympathy for the Train response, we will attempt to build on that. What we have said about equities is that, for now at least, they have found an equilibrium, with consensus forming that economic damage caused by the pandemic is offset by monetary and fiscal stimulus. Markets hate uncertainty and the huge policy response looks sufficient to remove a few months of this, with lessons learned from mistakes made during the Global Financial Crisis.

For my part, however, I would caution against any early revivial of animal spirits with so much uncertainty out there: from the efficacy of track and trace in the UK, when or, perhaps more accurately, if we get a vaccine, and how higher unemployment hits consumer-led economies like the UK and US.

While the broad recovery since the lows of May has obviously been welcomed by investors, there are growing suggestions it is a bear market rally and nothing more. Supporting this, Bank of America’s (BoA) latest monthly survey of fund managers revealed two-thirds believe the rally is set for a reversal, with a second wave of Covid-19 top of a large pile of concerns. Just 10% of respondents expect a V-shaped recovery and, in addition to unemployment, this lack of a quick bounce back is a major worry for thousands of businesses hoping for a return to some kind of normality.

Indicating the dichotomy currently at play for investors, however, the same report also claims equities are at their most attractive relative to bonds for more than 70 years. The yield of the S&P 500 is nearly triple that of the 10-year Treasury, which has historically been followed by stocks outperforming bonds over the next 12 months. In light of this, despite everything else going on, BoA is asking whether this could finally drive the fabled great rotation from bonds into equities.

As we have written in recent months, current conditions give us an opportunity to re-balance our portfolios to take on more risk, while remaining within our volatility parameters. We remain patient however and are happy to make these moves at our own pace, ignoring the ever-present emotional pull to rush into decisions without knowing all the facts. When we do move, we will focus on cheaper areas, veering away from the increasingly expensive US growth names, despite the latter continuing to lead equity markets.

Offering some support for this, around 60% of investors (with thanks to the BoA survey once again) currently see US technology and growth stocks as the most crowded trade in the market, with portfolios at their most overweight in these areas since 2015. This is particularly the case for our passive peers, for which a market cap weighted exposure to the MSCI World Index would mean an equity allocation is automatically more than 60% in expensive and overbought US large caps.

There would be little surprise to see a rotation into cheaper names, at least in the short term. Of course, this rests on the nature of the next cycle and whether it affirms current trends of low growth and subdued inflation or offers an opportunity for a major reset. As we have written elsewhere, we believe longer-term performance trends in terms of value versus growth, emerging markets versus the US and small caps versus large can re-emerge in due course.

Our analogy is that we remain in the middle lane of the motorway, moving through a tunnel, but ready to manoeuvre into the fast lane in certain cheaper areas when we see some light. This will be a long march back to ‘normal’ human behaviour, however, and we continue to believe this will have a greater impact on earnings than the great discounting machines around the world are currently signalling.

For a comprehensive list of common financial words and terms, see our glossary here.


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Please remember that past performance is not a guide to future performance and the value of an investment and any income generated from them can fall as well as rise and is not guaranteed, therefore you may not get back the amount originally invested and potentially risk total loss of capital.

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Friday, June 5, 2020, 4:06 PM