In previous market updates throughout 2020, my fellow research team and I have outlined the arduous challenge COVID-19 presents for our public healthcare services and how politicians face a perilous tightrope; balancing, on the one hand the re-opening of their domestic economies against, on the other, trying to minimise the spread of coronavirus infections so as not to overwhelm our health services. As public fatigue grows in the face of social distancing requirements and further regional lockdowns, the fourth quarter looks set to test both our patience and the resilience of the global economy as governments try to preserve the economic recovery by avoiding the need for national lockdown action.
At the end of the third quarter, there had been approximately 30 million coronavirus cases recorded globally. Sadly the pandemic’s death toll had surpassed one million by the 30th September 2020. Yet markets, over the quarter, managed to look through the majority of the negative pandemic headlines, took some comfort in a lower hospitalisation and death rate relative to COVID-19 cases, and instead took greater comfort in the easing of lockdown conditions that supported a global economic rebound from the April nadir.
Q3 2020 review
The third quarter of 2020 was generally seen as a positive quarter for risk assets as the global economy continued to regain strength and momentum as the broad regional lockdowns, induced in response to the first wave of the COVID-19 pandemic, further eased. Developed market equities, represented by the MSCI World index, rose +7.5% over the period but emerging market equities outperformed, rising +8.7% as investor risk appetite gradually returned.
Nevertheless, we think it is important to point out that market volatility (an indicator of the relative size of market ups and downs) remained elevated over the third quarter, which implies that risk appetites remain fragile. Volatility did initially move lower through July and into the beginning of August to reflect the broad improvement in economic data and forward looking market growth indicators remaining within expansionary territory. Yet, volatility once again shifted higher towards the end of August and into September as rising COVID-19 cases in Europe, alongside a rapid rise in cases in India, brought to the surface prior concerns of a second COVID-19 wave in the northern hemisphere.
North America
Looking across the pond, US equities as represented by the S&P 500 index rose +8.5% over Q3 as the economic recovery showed signs of strengthening. Within the US, from a sector perspective consumer discretionary stocks led the pack whilst the energy sector delivered negative returns given the ongoing weakness in the oil price. From an equity style perspective, growth stocks continued their year to date outperformance versus value stocks through the third quarter. Their performance was helped, in part, by the prevailing record low interest rate environment that is regularly observed to be more supportive of the more stretched valuations of high growth companies. Both technology and healthcare stocks continue to perform strongly with investors taking comfort in the relatively more resilient earnings profile throughout the COVID-19 pandemic.
UKIn the UK, large cap equities as represented by the FTSE 100 index, fell -4.9% over the quarter reinforcing their lag behind other developed market equity indices this year. Underneath the broad index, weakness stemmed from the financial and energy sectors where the low level of interest rates and a weak oil price held back each of these market segments respectively. Additionally, a lack of progress between the UK and the EU in regards to Brexit negotiations increased the likelihood of a hard Brexit into year-end which further unsettled investor confidence. Linked to this, the UK Internal Market Bill that seeks to create unified regulations and standards, across the entire UK region, post withdrawal from Brussels apparently contravenes international law. Unsurprisingly this raised political tensions between Westminster, the EU and the devolved governmental powers across the UK. Meanwhile, rising COVID-19 cases in the UK which led to a number of localised regional lockdowns stepped up concerns about the UK’s economic health. This was further compounded by Chancellor Rishi Sunak’s announcement that there would not be a blanket extension to the government’s furlough scheme from October which risks a spike in unemployment.
EuropeIn continental Europe, equities fell -1.3% as represented by the Euro Stoxx 50. Improvements in economic momentum slowed over the quarter on the back of a worsening COVID-19 second wave and as a strengthening euro against the US dollar weighed on export competitiveness. In July, EU leaders finally reached agreement for a EUR750bn EU Recovery Fund which was seen as an important fiscal expansion agreement across the entire euro area block. With monetary policy already ultra-accommodative, we think this agreement further demonstrates a key theme of 2020; governments feeling the pressure to materially expand fiscal policy to relieve the economic woes brought about by the coronavirus outbreak.
JapanJapanese equities rose over the quarter with the export orientated Topix index climbing +4.3%. In late August, markets digested the news of Prime Minister Abe’s sudden resignation as a result of renewed health concerns. Given his tenure as the longest serving prime minister in Japan’s history his departure leaves a considerable void to fill. Abenomics has helped drive forward much needed corporate reform in Japan. New Prime Minister Yoshihide Suga, given his close links to Abe, is expected to provide continuity on this front.
Emerging Markets
Emerging Markets equities delivered the strongest performance over the quarter despite some countries still undergoing highly restrictive lockdowns. In China, data showed that life continued to normalise over the quarter with business operations returning closer towards pre-COVID activity levels. This juxtaposed a backdrop of heightened geopolitical tensions between the US and China. President Trump removed Hong Kong’s special trading status and instigated additional restrictions on some Chinese company operations in the US, amongst a raft of other confrontational foreign policy measures.
Fixed IncomeIn fixed income, the risk-on market sentiment helped corporate bonds to outperform government bonds over the quarter. Importantly, from a monetary policy perspective, in late August Federal Reserve Chairman Jerome Powell announced the US central bank’s new average inflation targeting policy (AITP) which indicated a greater willingness to allow inflation to run above the 2% inflation target. This revised approach seems to reinforce a greater inflationary tolerance from the US central bank which could help make up for the perennial undershoot of inflation after the 2008/09 global financial crisis. To us, it re-underscores the possibility of a ‘lower for longer’ monetary policy mind-set. This was also evident in the UK where the Bank of England somewhat unsettled markets by not ruling out the possibility of negative interest rate policy – negative interests are a concern because they are believed to undermine bank lending.
CommoditiesThe price of precious metals such as gold and silver rose over the quarter (by +5% and +27% respectively). Prices of precious metals were already elevated due to the unprecedented monetary expansion being pursued by central banks across the world. Further price appreciations over the quarter were thought to reflect the rising possibility of longer term inflation as the global economy showed tentative signs of reflation. The price of industrial metals increased in response to rising expectations of fiscal packages providing a boost to infrastructure spending particularly in China. The price of oil was broadly unchanged over the quarter. Though, this somewhat overlooks the intra-quarter -15% decline between late August and early September which appeared to reflect a resurgent worry about elevated supply levels and depressed demand. US oil consumption data appeared to ease at the same time that OPEC+ outlined it would taper back oil supply cuts from c. 9.7 million barrels per day to 7.7 million barrels per day from August through to December.
OutlookAs a team we expect market volatility to persist over the remainder of 2020 fuelled by political uncertainties such as the US Presidential election and the United Kingdom’s withdrawal from the European Union. In addition, from a virus perspective, many countries are bracing themselves for an uptick in coronavirus cases. We are now entering a colder weather period where many of us will spend more time indoors. With coronavirus thought to survive longer in cooler environments this is likely to increase the risk of transmissions and infections.
It is yet to be seen whether the market will have the same tolerance to look through rising case numbers as it did for the majority of the third quarter or whether markets could face a correction. In the face of adversity, we remain committed to actively managing our clients’ portfolios in a diversified manner to provide broad exposure across geographies and sectors. This is ingrained within our approach to investment management at JM Finn, alongside our preference to invest in high quality businesses, with competitive advantages and structural growth prospects.
