With regard to the US election, whether we see a Democratic or Republican victory – a final result will provide certainty to investors and with it some short-term support to equity markets. The only outcome that could challenge that view would be a contested result. Closer to home and Brexit trade negotiations are reaching some form of conclusion (deal or no-deal). Economic growth is already weak on both sides of the Channel and not reaching a trade deal would only exacerbate this further. We believe that a deal will be struck, as this is in the interests of both parties, but it will be last minute as typically happens with the European Union negotiators.
All these factors are, in the short-term, creating uncertainty and, as a result, stock markets have trended lower over the past week in particular. We are also conscious that the headlines over the next few weeks may become progressively worse and there is a real possibility, as we saw earlier in the year, that this lockdown could be extended beyond the initial period announced.
However, it’s not all bad news…
Many countries, particularly in Asia, have handled the pandemic better than developed nations in Europe and the Americas, predominantly as a result of their experience of previous pandemics (SARS and MURS) and greater adherence by the wider populous to the rules. This is a large part of the global population – we are increasingly invested within this area of the global economy.
For every day that goes by we move closer to a viable and distributable vaccine becoming available to combat the pandemic and protect those most vulnerable. AstraZeneca and Pfizer both have promising treatments due to come on-line soon and the UK Government have already ordered millions of doses. Having a vaccine programme in place during Q1 2021 seems a realistic possibility and would allow large parts of economic activity to fully resume.
Finally, we enter this lockdown better prepared and with more information having already seen the impact of the first lockdown on the economy and stock markets. The first lockdown forced the UK into recession in leading to a monumental 20% fall in GDP in the second quarter of 2020. However, we did witness a significant recovery in UK GDP once lockdown restrictions were eased. “Lockdown 2.0” is not as severe as the initial lockdown with some areas of the economy remaining open. This means the economic impact should be less severe than what we experienced in the second quarter.
Interestingly, most global stock markets hit a low point on the 23rd March. This coincided with Boris Johnson’s announcement that the country would be moving into a full lockdown, instructing the population to stay at home whilst requiring some non-essential businesses to close. The low in markets was also the day that the UK announced full lockdown restriction.
Why is this the case?
Stock markets are forward-looking and were already under pressure during February and March as Covid-19 cases increased and with the prospect of tighter restrictions looming. When the first lockdown was announced investors began to look ahead and anticipate when restrictions could be eased leading to a gradual reopening of the economy – this led to stock markets recovering over the Summer and early Autumn.
This is not just a phenomenon associated with the current environment. This behaviour has been observed over many periods of time – in fact, some of the best returns for an equity investor come when the economy is technically in recession. This is because the stock market is forward-looking and starts to account for the economic recovery already taking place. The great financial crisis in 2007 to 2009 was a good example of this – the stock market bottomed in early March 2009, but the economy didn’t emerge from recession until the end of the year.
When we look forward 9 months or so from today, the following scenarios appear likely:
The US election will have taken place with a President (either Biden or Trump) in place for four years,
Brexit trade negotiations have concluded and
a successful vaccine is found and, as a consequence, a global economic recovery is well underway.
Government and Central Bankers to step in (again)
One of the main consequences of the first lockdown was the speed and synchronisation of support from both Central Banks and Governments. Therefore, expect to see further monetary and fiscal stimulus. Another lockdown will have a significant negative impact on the economy and therefore the authorities will look to protect and support as much as possible. We have already seen the furlough scheme extended in the UK, and in the US a huge fiscal package is due to be announced post the US election. This is likely to help support markets in the short term whilst the economy recovers. It is equally probable that interest rates in the UK could move into negative territory. There are two Bank of England meetings before the end of the year, one on Thursday 5th November and one a week before Christmas on the 17th December.
Where is Luna invested and what have we been doing?
We are invested in diversified multi-asset portfolios, via the individual funds and direct securities held. Luna’s client investments are not just invested in equity markets, each portfolio has exposure to cash, bonds and alternative assets.
The increased number of Coronavirus cases in Europe became evident in September and suggested a new lockdown was possible; crucially this was also at a time when asset prices were higher. We have recently removed all property and UK banking exposure. Both sectors proved to be more at risk in the lockdown in March and we believed this was likely to be repeated in a second lockdown scenario.
Currently, the proceeds of these sales are held in cash, providing some protection to your portfolio and we are looking at reinvestment opportunities as they present themselves.
We have also recently reduced exposure to UK corporate bonds and rotated the proceeds into Global corporate bonds – in doing so increasing your portfolio’s exposure to the World’s currency reserve, the US Dollar. There are a number of safe-haven assets in the world that can protect portfolios in times of stress and the US Dollar is one example. This will also help to support portfolios should we see a negative Brexit outcome later in the year.
Additionally, one of our preferred themes is for gold and silver miners. The substantial increase in debt on the balance sheets of both Central Banks and Governments alike could prove to be an inflationary spark and precious metals have already moved higher in anticipation of increased inflation and Global economic uncertainty.
Match objectives with long term investing
Stock markets tend to react quickly on the downside during events such as this and it can feel uncomfortable. What is happening currently is short term volatility, but we are long term investors. We should remain focussed on your long-term financial objectives and by remaining invested we will take advantage of the recovery of both the economy and in turn stock markets – some of the best days in terms of market returns are following sizeable market falls and we do not wish to miss out on those ‘recovery days’ given client portfolios will be invested for periods of between 5 to 30 years into the future.
We should focus on this time period to meet long term goals and (try to) ignore the short-term market noise. It is important to remain calm during periods of extreme volatility and not to disinvest at what could be the worst possible time. As mentioned earlier, some of the best returns in stock markets come when an economy is in recession. Therefore, we are looking to take advantage of short-term volatility and believe current events are creating an attractive long-term entry point within several asset classes.
Alex Brandreth, Chief Investment Officer
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