MARKET COMMENTARY – AUGUST 2020

Coronavirus related developments continue to overshadow the global economy although July provided further evidence of economic activity improving since lockdown measures were eased.  An increase in the pace of new infections particularly in the US was a concern although towards the end of the month there were signs of this slowing.  Hopes for a vaccine were boosted by positive early stage trial results including those from the Oxford University based team.

A weakening of the US dollar against the major currencies including sterling, meant returns for UK investors were limited although most markets continued to make progress in local currency terms.  While equity markets remain relatively strong, evidence of risk aversion has come from government bonds holding onto their gains for the year and a continued rise in the value of gold, which increased by 11% in July.

Major central banks continue to provide vital support to the global economy however their actions were more limited in July having already flooded the market with liquidity and taken interest rates to historic lows.  Governments have come under pressure to provide additional fiscal support in the absence of further options for central banks and in the US Congress is debating the extent to which unemployment benefits should be extended and whether further stimulus payments should be provided to households.  A rise in virus infection rates continued throughout most of July with areas of the country previously less affected showing sharp increases resulting in the reversal or pausing of reopening plans.  The increased amount of testing has been a factor and lower death rates than the previous peak are perhaps evidence of improved treatments and more rigid social distancing among older age groups.

US GDP for the second quarter fell by an annualised rate of 32.9% compared with the previous quarter, confirming the largest decline since the Second World War.  Investors had been anticipating this and are now more concerned with evidence of a recovery in economic data.  US retail sales were encouraging rebounding by 20% since their low in April and stand just below their peak in January.  Some data has been less encouraging though as the virus spread has increased. Smaller businesses for example are still struggling to recover previous revenue levels and the labour market has shown signs of stalling with initial jobless claims remaining high, consumer confidence readings also fell.  As in many other developed countries, consumer incomes in the US have been protected by support measures from the Government providing $1,200 stimulus cheques as well as a $600 per week boost to unemployment benefits.  Further stimulus is expected to be agreed by Congress albeit probably less generous than previous measures.  US second quarter corporate earnings so far have showed substantial declines although in most cases have been a little stronger than the markets expectation of a 45% year on year decline.

Europe appears to have managed the virus better than many other regions. Rising cases have though given cause for concern recently, particularly in Germany where infections remained low for some time and Spain where the peak of the summer tourist season has suffered, casting doubt on the potential for a swift economic recovery.  The increase in infections as economies reopen is leading to a potentially disruptive and geographically differentiated recovery with an effective vaccine being the necessary catalyst for a more sustained economic rebound. This is unless the virus can be suppressed more comprehensively by other means without restrictions on activity.

Eurozone second quarter GDP fell by 12.1% compared to the previous quarter, the largest quarterly decline in the eurozone’s history.  Mixed economic data showed consumer confidence stalling after healthy gains in previous months, although some measures of business confidence were stronger.  Importantly the European Union agreed a €750bn recovery fund in response to the coronavirus, this will be backed by common bond issuance by the European Commission for the first time, which is a step towards fiscal integration across the EU and seen as positive for European assets, prompting bonds issued by the weaker Mediterranean countries including Italy and Spain to rise in value.

In the UK, daily cases of COVID-19 have generally been falling but localised outbreaks and the measures imposed to suppress them, have raised question marks over economic recovery.  The Chancellor’s measures to boost demand have included reducing stamp duty on house purchases, cutting VAT for the food and hospitality sectors and offering further incentives for companies to take back their furloughed staff when the scheme is due to be wound up at the end of October.

The virus continues to spread significantly in Brazil, India and a number of African countries with an outbreak in Hong Kong also leading to a reintroduction of restrictions. A number of countries in the Far East including China, South Korea and Taiwan have recovered well without any significant increase in cases and appear to demonstrate that recovery is possible without a vaccine.  In China, GDP for the second quarter grew by 3.2% year on year and the equity market rose strongly in July.

The rapid policy response to the pandemic from central banks and governments and its scale has helped to support markets and provide a bridge to the stage at which the virus will be controlled or eliminated.  It would seem however that full economic recovery can only take place if the easing of restrictions necessary to allow this does not also lead to a rise in infections.  The extent to which governments are successful in achieving this will inevitably be a key factor in the outlook from here, although there have been some encouraging signs from a number of the vaccine research teams.

Given the uncertainty that continues to overshadow the outlook for the global economy, an emphasis on quality across both equites and bonds along with a focus on ensuring valuations are realistic compared to the prospects for businesses remains a reasonable approach.  As ever, diversification remains important and this applies beyond fixed income where very low yields and high prices particularly of government bonds means that their diversification effects may be more limited than has been the case previously.

Performance to 5 August 2020

 *July 2020