The second quarter of 2020 could not have been more different from the first. With welcome relief, the UK and the rest of the world are beginning to reopen their economies after 3 months of lockdown.
While there are various challenges ahead, things seem more positive than they did 3 months ago with early signs of economic recovery resulting in risk appetite returning rapidly during the quarter as investors looked beyond the current crises and into recovery.
Both fixed income and equity markets have rallied since the March lows, a result of monetary and fiscal stimulus coupled with the gradual reopening of economies. Except for UK Property, all asset classes are in positive territory over the quarter. The FTSE USA Index has been the standout performer, returning 21.81%, but all equity indices have posted double-digit returns.
We remain concerned about how working practices adopted during lockdown will exacerbate already struggling property funds who are likely to have to factor in downgraded office space valuations in addition to their decidedly unhealthy looking retail portfolios.
The UK has lagged other markets slightly, largely due to the composition of the FTSE100 index which includes significant weighting to hard-hit sectors such as banking, oil and gas. In a similar vein, the US is now back to near all-time highs thanks to a continued rally in technology, which represents a large part of that index. However, underneath this high-level figure, there remains marked sectoral differentiation. In Asia, where the outbreak first began, they are further down the journey of reopening their economies, and indeed the FTSE Asia Pacific ex-Japan index has returned nearly 20%.
It has been pleasing to note that traditionally lower risk portfolios have particularly benefited from resurgent fixed income exposure as Corporate Bonds have returned 9.03% as investors reassessed potential default rates. Index-Linked Gilts have fared even better, pricing in a potential increase in inflation on the back of Central Bank intervention and returning 10.32%. Conventional Gilts are up 2.45% over the quarter, having demonstrated their defensive characteristics during the initial sell-off earlier this year.
Traditionally higher risk portfolios have benefitted twice from their overseas equity exposure as those markets recover and sterling was buffeted during the storm, which although it may make your holiday abroad more expensive, had an immediate and positive impact on global equity holdings and on some UK Equities which predominantly trade internationally in US dollars.
However, despite the bounce in equities over the quarter, as a result of the COVID-19 sell-off (and subsequent hit to company earnings), the best performer over the last 12 months has been UK Gilts, with a return of 11.18%.
Due to the magnitude of the falls in Q1, the UK, Europe and Emerging Market Equity indices remain in negative territory over 12 months, alongside Property. Though the latter, despite it’s obvious current predicament, did provide some much-needed ballast during recent volatility.
It might seem rather odd to have had such a powerful recovery in markets during the past quarter, particularly with the human and economic cost of the coronavirus crisis being so grim and cloaked in uncertainty. The relaxation of lockdowns in recent weeks has been encouraging, but many are only just starting to have some effect and we still have a long way to go to return to ‘normality’, whatever that looks like: large swathes of the global economy, particularly in the hospitality, leisure and travel sectors, as well a vast percentage of the global population, remain in various states of lockdown or continue to have restrictive measures placed upon them.
There is still the risk that relaxations may have been premature. The improvement in financial market sentiment, however, can be explained not only by the combination of the expected rebound in corporate profitability but also by the further extensive stimulus and support packages doled out by governments and central banks: interest rates are now at or close to zero in many developed markets, quantitative easing has either resumed or been extended and there are deep commitments from monetary authorities to do even more if necessary. All these collective measures have pumped huge amounts of liquidity into the financial system, lowering borrowing costs for business and restoring confidence. In turn it has coaxed investors out of cash into the relative attraction of a wide range of risk assets which offer a real, albeit uncertain and volatile return.
During this interesting period we’ve deliberately not introduced any knee-jerk responses. When your sailing boat gets hit by a storm, the sensible sailor battens down the hatches and has a cup of tea whilst the worst of it passes.
Knee-jerk reactions in financial markets is how investors get hurt.
However, because of the extreme volatility, to protect our clients we continued our temporary hold on implementing switches within client’s portfolios. We’re now starting to relax this policy as volatility returns to more acceptable levels.
We are under no illusion, we’re not expecting volatility to completely disappear as the pandemic and its consequences are far from over. The long term impact on certain sectors, especially leisure, hospitality and aviation, is uncertain and in the short-term those sectors and employment more generally are likely to be acutely challenged.
As good news and bad news (or the rumour of either) continue to compete as click-bait on a daily basis, capital markets and society will be troubled by uncertainties for some time to come, positive vaccine news will undoubtedly boost global markets, whilst Second Wave Fears will not.
When the time comes for us to scratch our heads and start to pen our Q3 2020 review, we’ll be able to turn our attention to more mundane matters like the forthcoming US presidential election and the end of the UK’s BREXIT transition period.
Please remember that the value of investments and income from them can fluctuate (this may partially be the result of exchange rate fluctuations) and investors may get back less than the amount invested. Past performance is not a guide to future performance.
Don’t hesitate to get in touch if you’ve got any queries or just fancy a chat, we’re here to support you.li