Quarter 2 2020 Market Review and Quarter 3 2020 Outlook
In the January - March quarter, we saw a fall in the UK FTSE All Share of 25.1%, while the FTSE All World (as we reported in our previous note) fell by 15.9%. Even larger falls were seen in Europe ex UK of 17.3% and Emerging Markets fell by 19.0%. As most developed economies went into lockdown during March, Q1 saw GDP falls of 9.8% in China, 3.6% in the Eurozone, 2.2% in the UK and a fall of just over 1% in the US.
In Q2 the equity markets in particular have rebounded strongly. In the UK, the FTSE All-Share rose by 10.2%; in sterling terms the US rose by 21.0%; in Japan the Topix rose by 11.7%; while Emerging markets and Europe ex UK both rose by close to 19%. Meanwhile in the fixed interest markets, UK gilts gained 2.5%; Indexed Linked were very strong rising 10.3% and Corporates rose 9.0%.
So the fastest 30% fall in history was quickly followed by the largest advance in market history. The market rebound does mean that, in terms of value, markets are not cheap. However, the outlook has improved as enormous fiscal and monetary announcements have been announced. The big question is whether the markets have gained too much and too soon?
There remain a number of risks to the markets. Firstly, although there are sporadic outbreaks it is not clear whether or not there will be a second wave of virus infections and deaths. If a second wave appears and requires lockdowns, then this would have a negative impact on markets. On the positive side though, most health services appear to be in a better place to handle a second wave, in terms of capacity and knowledge. Positive news regarding a vaccine would of course give an upwards boost to equity markets.
In the US, the US Federal Reserve cut interest rates to zero and announced the most significant support package since the Second World War. However, the election of the President is not going how the markets had been expecting. The polls have been indicating that President Trump has not performed well during the pandemic and have been showing Joe Biden in the lead. A Biden win could have a significant downwards effect on the US equity market, as Mr Biden has indicated that he plans to reverse some or all of President Trump's corporate tax cuts. The US economy was healthy before COVID 19 arrived, which might hold promise for the recovery. Also, the US injection has been of the order of $2 trillion, which massively exceeds the response to the 2008 financial crisis.
In the UK, many commentators are suggesting we have been one of the hardest hit in terms of infections and deaths. The UK also has the uncertainty to come of the Brexit negotiations, which will add extra volatility to the markets in the run up towards the year end. It is in both sides interest to do a deal but, as usual in dealings with the EU, any deal is likely to be a last minute one. But if there is a deal this could well be very positive for the UK equity market.
Oil had fallen to $21 in Q1, impacted by the row between Russia and Saudi Arabia. Helped by the subsequent resolution of this disagreement, oil rose in Q2 to $41. But commodity prices overall have continued to lag in their recovery.
Longer term, the global economy has taken a major hit and there is substantial spare capacity in all developed countries. The virus and the lockdowns are reinforcing the move away from "just in time" supply chains and back to local supply chains; particularly in the areas of food and medical supplies. This trend is likely to negatively affect profit margins and may be exacerbated by eventual tax rises to begin paying for the support. This Central Bank support has been at unprecedented levels and interest rates are at zero or lower. There is not likely though to be any rush to increase interest rates, because Central Banks too will want to see how the path of the virus develops. This virus has no close precedent in its magnitude and we are still in the learning process.
Stock prices are cheap relative to bonds, but by historical standards of Price / Earnings ratios are not cheap in themselves and the earnings outlook for companies remains cloudy. Some companies have reacted to this uncertainty by cutting their dividends, which is also negatively impacting the valuation of equities. While it seems likely that hopefully the worst of the recession is over, global economic levels are still low. In addition, a number of industries will continue to be affected by the virus, particularly the leisure, travel, holiday and pub / restaurant industries. Given the damage done, it seems that profit growth could be slower than analysts hope. Although a lot of the bad news may be priced-in, uncertainty and market volatility will remain high. A prudent emphasis on equity markets seems the appropriate strategy.