Coronavirus (COVID-19) Update – 14th September 2020
It has been seven weeks since our last coronavirus update and, in some areas,, there has been lots of change and in others, very little. It has been hard to keep track of which countries are on or off the UK quarantine list but, whether or not they managed to squeeze in a foreign holiday, some semblance of normality has resumed for most families with the return to school for the start of the Autumn term, after almost six months at home. Long may that continue.
For investors, up until the first week of September, it was very much business as usual. The summer months can historically be tricky for global stock markets even without a pandemic to contend with, but investors have continued to enjoy positive returns. From the 24th July to 2nd September the MSCI World index rose 4.88% led by the S&P 500 which rose 7.20% (11.52% in dollars). However, the start of September saw a correction with the MSCI World index declining by 1.16% and the S&P 500 falling -2.88% (6.67% in dollars) as the big tech stocks suffered heavy losses. At one point, the share price of Tesla had declined by a third in the space of five days.
The FTSE All Share fared less well with a 2.36% decline in the same period up until 2nd September but since then a fall in the value of sterling and the positive translation effect of dollar denominated earnings of some of the largest FTSE constituents has conversely led to a rise of 1.62% in the index to 9th September. Overall, however, the UK stock market remains in the doldrums, having declined 17.91% so far this year compared to a 5.33% rise in the MSCI World.
Over the last week all major markets have stabilised, but questions remain:
Is this the end of the tech rally and by association the bull market?
Is there going to be a change in market leadership from growth to value with previous laggards such as banks, energy and travel and leisure, set to outperform?
Is the UK ever going to recover and should Apple really be worth more than the whole of the FTSE 100?
These questions are all inextricably linked but the lack of technology and prevalence of value-oriented sectors in the FTSE 100 does not fully explain the underperformance of the UK market which continues to suffer from extremely negative sentiment and fund outflows. Clearly there is some justification for this, given increasing concerns about Brexit and a lack of progress in EU trade talks, consternation that the government might be prepared to break the law (“in a limited and specific way”) by reneging on elements of the Withdrawal Agreement and an escalation in the number of positive Covid tests.
However, there is plenty to suggest that the bad news is already in the price. The FTSE All-Share has underperformed the S&P 500 by 24% over the past six months and now trades at a 12-month forward price earnings ratio of 15.4x. This compares to 22.5x for the S&P 500 and this gap is as wide as its ever been. Similar companies in the same sector with international earnings are trading at lower valuations than global counterparts simply because of the country of their listing. History suggests that if asset allocators do not recognise this value it seems likely that trade buyers will. Moreover, if a deal between the UK and EU is agreed then then sentiment is likely to change very quickly. There is further scope for the UK stock market to perform well if a vaccine is found or we find out that we are closer to some sort of herd immunity (perhaps via a natural “disease break point”) than we currently realise.
The data for this is mixed but it seems highly possible that an easing of social distancing measures (I appreciate how optimistic this may sound on the first day of the “rule of six” coming into UK law but the situation is nothing if not fluid) and a resumption of business as usual could lead to a discernible pickup in inflation expectations, which would in turn provide a significant tailwind for value oriented investments. One of the reasons why growth stocks have done so well is that with interest rates on the floor there is barely any requirement to discount future earnings. However, if inflation starts to rise against a backdrop of improving fundamentals and given the extraordinary amount of fiscal and monetary stimulus which the government has unleashed to deal with the pandemic, then growth stocks will start to look very, very expensive and there is likely to be a rotation out of these into sectors such as financials, energy, travel and leisure as investors start to price in higher earnings. No one is denying the secular growth stories of the likes of Amazon or Google and it makes sense to maintain some exposure for the long term, but they may not be the market winners forever. Thus, if the sell-off in technology shares resumes then despite their being such a significant proportion of the S&P 500, it need not mean the end of the bull market. At a regional level the natural response would be a rotation from US to Europe, Emerging Markets and the UK.
If, on the other hand, there is no change in the virus narrative, economic activity remains sluggish and unemployment persists, governments will continue to keep interest rates low and the shares of this pandemic’s winners will likely remain in demand. With so much uncertainty, maintaining a diversified portfolio is essential.
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.
14th September 2020
RiverPeak Wealth Limited