Quarter 3 2020 Market Review and Quarter 4 2020 Outlook
A few more months and this year will be over, one wonders if many will miss its passing? The equity market crash, in the early part of this year, ranks as one of the top five in this century, over a million lives have been lost worldwide because of this virus, and we have witnessed the significant negative impact of the virus on the global economy.
However, apart from for the UK market, Q3 was a positive quarter worldwide in both equity and bond markets. In the UK, the FT All Share fell by 2.9%; while Gilts fell by 1.2% and Indexed Linked by 2.2%. Outside the UK, the United States’ S&P 500 rose by 4.1% in sterling terms; whilst in Japan the gain was 2.8%. Europe ex UK equities rose by 1.6%; whilst the largest gains came in the Emerging Markets which saw a rise of 4.5%, after having been flat overall this year.
In the US, the unemployment rate dropped to 8.4% in the quarter down from the 10.2% level in July and Industrial production has seen an improvement. The Federal Reserve's move to target average inflation is a significant change and will allow an overshoot of the Fed's targets and will lengthen the Fed's support. Although overall the US equity market is close to all-time highs, we need to remember that this is because of the strong performance of the FAANGs (Facebook, Apple, Amazon, Netflix and Google). Adding Microsoft means these stocks are over 25% of the value of the S&P 500. Indeed, without these stocks the S&P would have fallen around 5% in the quarter. The FAANGs benefited significantly in the lockdown as consumers used and discovered their services and the low interest rates increased the value of their long-term earnings. However, there is likely to be some switch back to cheaper value stocks and US equities are beginning to be affected by the uncertainty of the election in the US.
In Europe, the EU approved a Euro 750 billion fund to support member countries. This fund is made up of 390 billion of grants and 360 billion of loans. These funds are being borrowed by the European Commission, but are guaranteed by all EU member countries, which is a move further along the path of integration and a significant level of economic support.
The poor performance of the UK markets is partly a reflection of the worries in the media about a second wave of the virus, the concerns of international investors about the outcome of the Brexit negotiations and the eventual effect on the UK economy. The Bank of England has flagged that it is exploring the possibility of negative interest rates, although this seems unlikely in the near term.
There are currently a wide range of factors impacting the potential future direction of market:
the prospect of negative interest rates
US / China trade tensions having eased in the Covid era
the EU appears to be moving forward positively in terms of agreeing a fiscal Covid response package
the noise in the UK economy is increasingly about Brexit again
China is again doing well economically
particularly in an election period the US authorities are unlikely to want to allow equities to slip (noting that the US market is more important to US voters due to their pension arrangements than is the case, for example, in continental Europe)
there is currently little leverage in markets and institutional fund managers continued to hold significant cash reserves
that the UK index is more diversified than previously due to relative moves of its constituents
Looking forward, one area to monitor is how quickly governments try to repay the debts which have been created in supporting the lockdowns and when they will raise taxes to reduce these borrowings. At present it seems unlikely that governments will rush to reduce these borrowings as it would be a move towards fiscal austerity, which is not a vote winning situation. Moreover, low interest rates mean that the cost of the extra borrowing is manageable. The issue will be when interest rates eventually begin to rise.
The markets are likely to experience volatility in the run up to the US election and afterwards if Joe Biden wins, as the markets will then have to price in his tax rises and policies. But outside the US, accommodative Central Banks and an ongoing economic recovery are likely to be supportive for equity markets. There will eventually come a time when Central Banks signal higher interest rates, but this will be when unemployment has reached lower levels and we are some way from this environment. Markets may look ahead to this and there is a risk that bond yields will rise from the current low levels (which would negatively impact bond and equity valuations).