Coronavirus (COVID-19) Update – 24th July 2020
Despite news of rising infection rates in the US and elsewhere, notably Japan and Hong Kong, equity investors were rewarded with further positive returns over the past two weeks. The MSCI World index has advanced just shy of 3% in the last fortnight and since the start of the year has generated a respectable 3.73%. The best performing region has been Europe where the rate of infections seems to have been brought under reasonable control despite some renewed outbreaks in parts of Spain. The FTSE World Europe ex UK index rose almost 5% over the same period. The UK stock market continues to lag and although it rose by 2.68% in the last two weeks it remains down 16.62% for the year.
Investors were buoyed, it seems, by better than expected economic data with retail sales figures in the US showing a 7.5% increase in June following a record 18.2% increase in May. The enhanced unemployment benefit (worth an extra $600 a week to those who qualify) is, however, due to end on 31st July so this boost to spending could fade quite quickly. For this reason, it seems likely that Congress will vote to extend it, but this is not guaranteed.
By far the biggest piece of news this week has been the agreement by the twenty-seven EU member states, after a marathon summit lasting four days, to create a €750 billion EU recovery fund (also known as Next Generation EU) of jointly issued debt that will be issued by the European Commission. Although the amount payable as grants was reduced from €500 billion to €390 billion after opposition from the “frugal four” (Austria, Netherlands, Denmark and Sweden) – or five if Finland is included – the total size of the package remained the same with the balance being made up from loans which must be repaid but with very a low rate of interest over thirty years from 2027. This represents a major shift in policy with it now being possible to argue that this package sets a precedent that diminishes the probability of a break-up of the Euro over the long term and removes the rationale for why domestic facing European equities should trade at a discount. Weaker countries such as Italy and Spain are now being explicitly supported by the bloc as a whole and the additional fiscal stimulus should boost GDP growth over those years while the reform effort could also lift productivity growth over the medium to long term. This should help boost demand for European equities and credit.
Our preferred fund for European exposure, Blackrock European Dynamic, has been performing well already and stands to benefit further from increased demand for European equities. Year to date the fund has generated a return of 13.91% outperforming the FTSE World Europe ex UK index return of 2.79%.
Nigel Bolton, Head of the European Equity team at Blackrock, in a recent paper, has identified three key themes:
- A fast-paced rebound
Shared debt via the EU Recovery Fund could help to sustain what is already looking like a fast-paced recovery. Consumers had built up savings during the lockdown, but are now showing a propensity to spend. This is true in the US as well as the EU. US credit card data show spending fell -35% year-on-year at its trough and has subsequently almost fully recovered (source: Bank of America, June 2020). This compares to only a -3.5% fall in the 2008 global financial crisis. May US retail sales figures were the highest on record, by a factor of two. In Europe, consumers are attempting a return to normality. For instance, open-table restaurant bookings in Germany are up a 32% year-on-year, a remarkable turnaround from a nearly 100% decline only six weeks ago (source: BlackRock, Bloomberg, June 2020). In the industrial economy, global trade estimates look far too pessimistic, while trucking data for the US and Germany are back to 2019 levels already. Beaten up, early-cycle companies could stand to benefit if governments keep the virus under control without further actions that cause economic hardship.
- Rethinking European banks
The market is not quick to forget a crisis. The equities of European banks are being priced as if history is repeating itself. We believe this to be a potentially severe mispricing as a number of factors stand to benefit European banks. Government guarantees to businesses and consumers through this crisis should make the loss cycle for banks markedly less severe. Capital positions are significantly stronger and provisioning systems under reviewed accounting rules mean banks are better equipped to deal with any loss. Moreover, subsidy regimes from the ECB allow banks to borrow at -1% and lend out into the economy at a higher rate. As these new loans have government backing, they also require less bank capital; a recipe for improving Returns on Tangible Equity. Yet valuations are below the depths of the financial crisis. We’ve selectively reduced our long-held underweight to the sector as we believe earnings, and multiples, can improve from here.
- Investing in health
As a result of this crisis, many companies will move from ‘just in time’ to ‘just in case’ supply chains. The ‘just in case’ mentality is likely to have a positive long-term impact on health care services, with an improved capex cycle for capital equipment. We expect greater spending from China, where there is potential to introduce vaccine programmes where none existed before. Beyond the benefits of increased external investment, we see positive developments for digital innovation, which accelerated amid limited access to hospitals and social distancing policies in recent months. This extends to trial monitoring, where Novartis, for instance, has moved 100% to digital/remote monitoring. As well as reducing the burden on health care systems, we believe this innovation could improve return profiles for some of these businesses in the long-run as they seek to achieve more with the same research and marketing spend.
The Blackrock European Dynamic Fund, managed by Alister Hibbert and Giles Robarth, is actively managed and well-positioned to take advantage of these themes. Clearly numerous risks remain, and investors should be braced for further bouts of volatility especially if evidence of a second wave or prolonged first wave of viral infections gathers pace. European equities will not be unscathed if there is a market correction but with this week’s historic deal there does seem to be scope for European equities to outperform their global counterparts, reversing the scenario which has dominated the past ten years. The fund remains a key component in the diversified portfolios we recommend to clients.
We hope that all our clients stay safe and well. Please do get in touch if there is anything you would like to discuss further.
24th July 2020
RiverPeak Wealth Limited