MARKET COMMENTARY – MAY 2020

Markets rallied strongly in April following the unprecedented falls last month.  The COVID-19 virus continued to spread across the world but improving  statistics, including a reduction in the rate of infections, have led to a number of countries taking steps to gradually reopen their economies.  Provided there is no significant increase in infection rates resulting, progress is expected to continue, but this will undoubtedly be a ‘long haul’.  Substantial fiscal and monetary stimulus measures continued from governments and central banks in an attempt to reduce the impact of the restrictions on economic activity and restore some confidence to investment markets.

Volatility declined from the more extreme levels seen in March and the S&P 500 (US) recovered close to 60% of its decline from January’s peak.  There are of course concerns over global growth in the medium term and a very sharp decline in gross domestic product (GDP) across the board is expected, although the length and depth of this contraction will depend on the rapidity at which economies can successfully reopen and demand can be re-established.

The US presidential election in November will inevitably be a consideration for investors along with the ongoing management of the coronavirus spread.  The success of President Trump’s campaign will be closely linked to the handling of the pandemic, the direction of travel of markets and the state of the economy in the run up to the election.  Whilst fiscal stimulus measures have been huge, the number of jobless claims increased by 30 million in the last six weeks so a key factor will now be the numbers and speed at which the recently unemployed can return to work.

In terms of monetary policy, the Federal Reserve’s response to the pandemic has been dramatic in both size and speed and this has been mirrored by central banks around the world, including in the UK.  These responses have also resulted in unprecedented levels of borrowing as extremely expensive measures, such as the furloughing of millions of workers, have been adopted to restrict levels of longer term unemployment.

In the UK, the FTSE All Share underperformed most developed equity markets largely due to the significant exposure to the energy sector.  Over supply and reduced demand due to the enforced shutdowns have led to a steep decline in oil prices.  This of course has had an impact on oil producers and those associated, examples being the UK listed BP and Royal Dutch Shell, with the latter cutting its dividend in response to the more challenging outlook – lower oil prices should however aid economic recovery when this comes through.  Economic indicators for April took a similar path to those for Europe with business confidence and retails sales falling.  More positively however, the rate of virus infection in the UK is declining and the government is due to reveal a “roadmap” to ease lockdown measures on 10 May.

Turning to Europe, the number of new cases is also decreasing and gradual business reopening has taken place with Germany, Italy and Spain already having relaxed some restrictions – the economic backdrop though remains extremely challenging as business confidence has slumped to an all-time low.  The Eurozone’s real GDP contracted substantially in the first quarter of 2020 and the second quarter is likely to show an even steeper decline.  In this context, the European Central Bank (ECB) continued its quantitative easing programme, now with an emphasis on the purchase of government bonds of those countries demonstrating the greatest need, such as Spain and Italy.  Additional steps have also been taken in order to support lending to small and medium-sized businesses.

China’s economy has been gradually reopening and there has been a partial recovery in production, retail sales and investment.  Demand for Chinese goods from Europe and the United States where social distancing measures remain in place, may however remain weak.  In any event, it is far too early to expect a rebound in activity that offsets the impact of the prior decline in output.  Furthermore, China may have to maintain social distancing measures in particular sectors, leading to a slower recovery.  The People’s Bank of China (PBoC) continues (as elsewhere) to provide stimulus measures including cutting interest rates.

Fiscal and monetary stimulus measures have gone some way to fuelling a strong market rebound, in spite of the inevitably weaker economic data which is starting to illustrate the tremendous economic cost of the enforced shutdowns.  For companies, 2020 earnings estimates have been revised and are expected to decline substantially although there will be some areas of resilience, including certain technology focused businesses which have continued to perform strongly.  There is also the prospect of further dividend cuts as companies focus on bolstering balance sheets over profit distribution.  Whilst the willingness of central banks to intervene has moderated some of the risk, the pace of any economic recovery is expected to be gradual with the risk of a second wave of infection still a very real threat.  As usual, though particularly now, diversification by both region and asset class, including cash, is an important part of individual strategy, whilst a focus on defensive sectors and secure areas of the bond market may also provide a more solid foundation for portfolios.

Performance to 4 May 2020

 *April 2020