Looking past the crisis towards the recovery ahead
Stock markets ended 2020 on a positive note, pushing higher into January as investors continued to look through the horrific escalation in COVID-19 cases and focused on the planned vaccine rollout. Developed markets gained around 3% and Asian and emerging markets rose by over 6%, although a stronger pound reduced these numbers in sterling terms. Fixed interest bonds improved by around 1%.
A Brexit deal at last and fresh fiscal support on both sides of the Atlantic
The UK's departure from the EU almost slipped under the radar, but investors were relieved to learn that a deal of sorts had been cobbled together at the last minute. As further tiering and lockdowns were implemented, the chancellor announced an extension of the furlough scheme and a series of business loan schemes which had been due to end in January.
Across the Atlantic, the political drama continued with President Trump refusing to accept the election result and encouraging an invasion of the Senate by his supporters, an action that subsequently led to his second impeachment. The Democrats won both Senate seats in Georgia, giving them marginal control of the Senate. Investors concluded that this was manageable, as the tight margins and party infighting would prevent the more extreme policies from being approved. US Congress finally agreed a USD 900 billion economic fiscal relief package, including direct payments to individuals, unemployment aid and small business support.
The Fed commits to keeping rates at zero until inflation targets are met
The US Federal Reserve vowed to keep funnelling cash into financial markets until the recovery was secured, but reiterated that fiscal support was what was needed to help the real economy. Fed member Clarida went so far as to say that they were not going to raise rates until inflation had reached 2% for a full year. In the UK, members of the Bank of England's Monetary Policy Committee continued to discuss the prospect of negative interest rates. The search for income saw bond yields fall further, with Portugal the latest country to offer zero yields.
The US shows signs of excess as comparisons with 2000 emerge
The US stock market was the most pronounced case of overextended valuations, showing extreme levels by any number of measures, including forward earnings, as a ratio of US and global growth, and against commodity prices. This had led to comparisons with the top of the dotcom bubble in 2000. Other markets had rallied strongly but did not look as overvalued as the technology-heavy US indices.
One metric that did not show equities as overvalued was the equity risk premium, the amount by which equity yields exceed government bond yields. Record low bond yields had supported share prices in general and driven the price of companies dependent on future profits to extreme levels. If bond yields began to rise, this might prompt a correction, or alternatively a rotation from growth into value stocks, which would benefit the UK.
A note from the desk
I am pleased to share our monthly update on market events. The overview seeks to summarise market movements together with our views and the rationale for the positioning of investments going forward. As always, should any aspect of this commentary prompt a question, we would welcome the conversation.
Martyn Charlwood · Managing Director
The year ahead hinges on the vaccine rollout
A major spike in COVID-19 cases in the US and Europe was posing a renewed threat to the recovery, but if the vaccine rollout was successful, we could expect to see a trough in economic activity in the first quarter before conditions rapidly improved in the second. The problem was that stock markets had arguably already priced in this assumption, leaving them vulnerable to bad news on the pandemic and any disruption to the economic recovery.
The US bond market had been shifting focus towards reflation, spurred by expectations of a further fiscal package under Joe Biden. The yield on the US government 10-year bond had doubled from its summer low to 1.1%. Investors anticipated a rise in inflation in the spring as the oil price rebounded from its 2020 low of less than $20 a barrel. However, the consensus remained that there was too much slack in the economy to permit any real inflationary shock.
Record low bond yields have supported share prices and driven the price of growth stocks to extreme levels.
On balance, we felt that the recent acceleration in share prices left markets vulnerable to a setback, but were less certain of the magnitude. With the outcome of the initial Brexit deal and the US elections now determined, and the availability of the vaccine expected to reduce uncertainty, we anticipated more companies resuming or growing their dividends in 2021. Excluding worst-case scenarios, lower prices were likely to attract buyers searching for income or simply betting on better times ahead.
In November we reduced cash levels by increasing exposure to both UK and global equities. We maintained a mix of value and growth stocks while seeking to minimise exposure to the most extended US technology names.
Increased equity exposure
In November we reduced cash levels by increasing exposure to both UK and global equities. We were holding a mix of value and growth stocks but had sought to minimise exposure to US-listed technology giants, where valuations had become excessive.
Underweight fixed interest
We remained underweight fixed interest bonds and saw little value at close to record low yields, with 90% of global government debt yielding less than 1%.
Diversified across alternatives
Our portfolios diversified risk by investing in a wide range of assets using actively managed funds with sound investment processes. Alternative holdings included gold and silver, infrastructure, agriculture and absolute return strategies.
Important information
This article is a marketing communication intended for general information only. It does not constitute personal advice, a recommendation, or an offer to buy or sell any investment. If you are unsure whether an investment is suitable for your circumstances, please seek personal advice.
Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise. Capital values are at risk and not guaranteed. Forecasts and views expressed in this commentary represent our assessment at the time of writing and are subject to change.
To discuss how this commentary applies to your own portfolio, we would welcome a conversation.
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