River FOURcast: July 2020
Welcome to our monthly macro update, giving greater insight into our outlook for investment markets and the investment ideas that currently interest us.
We make our internal views more accessible using our four-phase framework, the River FOURcast. Much like a weather forecast, it provides a guide to what we think may be coming, and how we should position portfolios to prepare for the climate to come.
- In June, equity markets rose modestly while global corporate bonds also increased in value.
- Successful efforts to contain COVID-19 in many developed countries led to the reopening of some economies.
- However, it is clear this reopening process will not be smooth, as the swiftly rising case levels in much of the US show. Viral outbreaks are still out of control in several large developing countries.
- Measures of economic activity continued to improve, and governments and central banks continue to provide support, though maintaining this support will require political decisions in some places, most notably the US.
The S&P 500 rose 2%, lagging the tech-heavy NASDAQ, which hit all-time highs, showing the resilience of the tech sector. European and Asian equity markets delivered returns of 3-5%, reflecting improving sentiment as economies began to reopen.
Against a backdrop of weak credit conditions, expensive valuations and volatile economic expectations, we remain in the Downturn phase. As some countries begin to re-open there are early signs of economic improvements and the overwhelming policy response cannot be overlooked. The situation remains fragile as demonstrated by a recent surge in US cases. We continue to advocate exposure to high quality assets, as well as areas of the market supported by policy.
- Economic expectations are improving, but in the near-term, much continues to depend on the development of the virus, as well as the actions of governments and central banks in containing the fallout.
- Credit conditions improved modestly over the month although remain challenging overall. High yield spreads broadly held their ground, while investment grade spreads contracted further. In general, spreads remain below where economic data implies they should be, driven by significant central bank support.
- Valuations have continued to run higher from the lows in March. Despite the recent positive economic data, we believe equity and credit markets are still expensive on an economically adjusted basis.
Signs of Developed Economies Reopening
COVID cases continued to fall in most developed nations, although the US was a notable exception. This progress allowed some countries to start easing restrictions, a welcome step for many businesses, and there are signs of this reflected in real-time economic data.
Lockdown measures were lifted across many European countries, and in a bid to reach a new normality, the EU announced it would reopen its borders to 14 countries, including Australia, Canada and Japan. There are encouraging signs of economic activity starting to pick up in a number of sectors, including tourism, evident from rising consumer confidence and business optimism.
US economic data also improved, although with a resurgence in COVID cases this may prove short-lived. US mortgage applications and new vehicle sales rose in June, illustrating improving consumer sentiment. New orders components also rose, a sign of improving business confidence, and the capex outlook improved, a promising sign for future job creation.
Concerns of a Second Wave
Some US states, including Florida, California and Texas (which together account for approximately 28% of US GDP), have reintroduced measures to contain the virus. It is likely that other states will follow a similar course, suggesting the path to reopening the economy will not be smooth. It also casts doubt on the sustainability of recent positive economic data, both in the US and elsewhere.
Causalities of the Crisis
Despite increased economic activity in countries that are reopening, casualties remain. Oil & Gas companies (e.g. Whiting Petroleum, Diamond Offshore) and retailers (e.g. JC Penney, J Crew and Hertz) are among those who have filed for bankruptcy. This highlights the difference between winners and losers coming out of the crisis, and the need to stay biased towards quality companies.
Policy Support Continues to Grow
Global stimulus now stands at close to 30% of Global GDP, and in the US, Japan and the Eurozone, exceeds 40% of GDP. As we have said many times before, monetary and fiscal stimulus of this scale provides a powerful support for asset prices and cannot be ignored. Any winding down of stimulus is likely to act as a major headwind for markets, and may pose a risk in the coming months as fiscal stimulus programs start expiring.
In the US, stimulus measures providing individuals with an extra $600 a week of unemployment benefits are set to expire at the end of July. After that date, benefits will return to pre-pandemic levels, which vary by state but are considerably less. Democrats passed a bill in May to extend the program until 2021, but this has been met by opposition from Republicans. While it is likely that more fiscal support will be introduced before the end of July given the recent spike in COVID cases, a “fiscal cliff” would likely cause elevated market volatility.
Implications For Portfolios
With tentative signs of a pick-up in economic activity in some countries, albeit alongside a possible second wave of infections elsewhere, we are continuing to take a very selective approach to adding risk to portfolios.
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