River FOURcast: October 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.
- Equity markets fell over the month amidst a growing number of risks. Credit spreads widened modestly.
- The US election, rising COVID-19, cases and the impending Brexit deadline all contributed to rising uncertainty in financial markets.
- Stimulus continued to support the economy, but the recovery is uneven and imbalanced. Consumer confidence is rising, albeit off a low base.
- Valuations look expensive but must be viewed in context of the considerable policy response.
September saw major equity markets decline from their highs as investors weighed up lofty valuations with a growing number of risks. US equities fell close to 4%, while most other major markets fell about 2%.
Credit markets also fell, but underlying credit conditions continue to be supportive as a result of central bank purchases. Near term economic conditions are improving, albeit off a low base, with significant stimulus and low mortgage rates encouraging spending. But rising COVID-19 cases and tighter restrictions in many major economies are likely to make any economic recovery uneven and imbalanced. Despite modest market falls, equity and credit valuations remain expensive. As a result, we remain in the Downturn phase of the market cycle, but recognize that policy support continues to be the dominant factor for asset prices and warrants a moderate allocation to high quality risk assets.
- Economic expectations are improving but Hospitality and Leisure are clear laggards, while some manufacturing and industrial sectors are making good progress. Consumer confidence is rising, and government intervention has prevented mass long term unemployment for now. But as support is withdrawn, economic concerns are likely to materialize.
- Credit conditions have fallen slightly over the month but remain positive given the economic backdrop. Corporate borrowing costs remain low.
- Valuations continue to look expensive, particularly in the US, but must be viewed alongside the considerable policy response. This warrants a selective approach to risk assets, using tools such as structured equity to provide downside protection.
Rising COVID-19 Cases
Rising COVID-19 cases could set back the pace of economic recovery heading into the winter. The spike in new cases is not uniform across countries; while some US states and European countries are tightening restrictions again, China has had more success in reopening their economy safely. But social restrictions look inevitable going into the winter, and have scope to cause further market volatility and economic uncertainty. On the positive side, vaccine timelines have shortened dramatically since the start of the pandemic, and stimulus is already triple that of the 2008/2009 recession.
Brexit Deadline Looms
With the UK set to leave the EU in just 3 months’ time, negotiations are coming to a crescendo. The UK government’s move to overrule parts of the Withdrawal Agreement brought added skepticism a deal could be agreed, with Sterling weakening accordingly. Senior political figures have attempted to inject some impetus into talks ahead of the October 15th European Council, but Macron’s insistence on access to UK fishing waters remains a key sticking point. Failure to reach an agreement has potential to weaken UK and EU equity markets, in particular exporters who rely on cross border trade.
Biden remains the favorite, with his polling increasing after the first debate. Trump’s COVID-19 diagnosis also refocused conversation on the administration’s health response, with the potential for further damage to his re-election chances. Just as importantly, polls now show Democrats more likely to win control of the Senate, enabling a more progressive agenda on tax reform and healthcare.
Implications for Portfolios
Markets are largely proving resilient to the economic climate, thanks in part to continued policy support. But with the economic recovery uneven and imbalanced, and with notable risks on the horizon, we continue to favor high quality assets with strong balance sheets. Companies that came into this crisis with stronger balance sheets are in a better position to weather the storm and pick up cheap assets. Conversely, good companies with weak balance sheets will be distracted by restructuring. We believe this is an important theme, particularly in equity markets.
We also continue to believe that liquidity is highly important. We expect many illiquid assets to come under pressure as economic stresses emerge, and we do not think pricing sufficiently reflects this in many cases. In the coming months, it will be key to maintain higher levels of liquidity to take advantage of opportunities as they arise.
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