The World In A Week - Interim Update
It is happening again. President Donald Trump has been busy with his Twitter account this week and the focus of his attention is China. Trump’s increasingly critical comments of China could be a worry for the longer-term economic bounce back.
Whilst pent-up demand during lockdown is potentially a boost for US growth in the short term, restoring the level of growth to where it was before COVID-19 will require a stronger underlying economy, and reawakening trade tensions with China will not help.
There is more at play here than meets the eye though; casting China as the villain has been successful in the past for Trump’s approval ratings, and in a recent survey amongst Republican voters, disapproval of China is at 72%. With the US Presidential Election not far off, seeds are already being planted for campaign strategies. For the Trump team, it will be a difficult balancing act of building political support and ultimately keeping the trade deal alive.
In the UK we saw the official rate of inflation drop significantly from 1.5% in March to 0.8% for April, and below economists’ expectations of 0.9%. Driven downwards by falling commodity prices, as well as reduced spending and increased savings, a result of having so many people in lockdown. This has prompted the Bank of England to make a U-turn on the possibility of negative interest rates in the UK.
The Governor of the Bank of England, Andrew Bailey, confirmed that policy had changed slightly and that they were reviewing all tools possible to help alleviate the impact of the coronavirus. He did stress that the Bank needed time to consider the implications of such a move and they want to see how the economy reacts to the previous rate cut to 0.1% before enacting further monetary policy.
The World In A Week - Schools Out
A recent rally in equity markets has seen the S&P 500 only down by -2.6% in 2020 in Sterling terms. However, the FTSE All-Share remains the poorest performing equity asset class; down -23.0% for the year. The S&P 500’s recent upsurge partially attributes to the depreciation of Sterling which continued to drop last week amid stalling Brexit negotiations between the UK and the EU.
Rishi Sunak has extended the Government furlough scheme to the end of October as he aims to curb the number of job losses caused from the virus. Already 7.5 million workers are on the furlough scheme, which equates to 23% of the total working population. The Government initiative is estimated to cost £14 billion per month and could reach £80 billion.
The reopening of schools appears to be the biggest debate as Michael Gove discussed his intentions to reopen schools providing conditions were met that include smaller classes and staggered arrivals. Denmark was one of the first countries to reopen schools back in April, prioritising its younger children to return to class, whereas Germany has given precedence to their older students. Much of Europe have reopened their schools and have taken precautionary measures to ensure a safe environment including regular breaks to use hand-washing facilities. Globally, almost 1.6 billion students have been affected by the pandemic and further guidelines are expected to be revealed later this week.
The renewable energy sector has flourished in recent months from lower electricity demand and brighter weather conditions with solar farms powering almost 30% of the grid. The UK has now reached 34 days without operating with coal as of the 14th May. Global energy demand has declined 3.8% in Q1 of 2020 with coal demand falling by 8% and oil demand by 5%. Besides a greener environment, the pandemic has highlighted the importance of international co-ordination and co-operation, as we have seen social distancing operated on a global scale. If a similar stance is taken going forwards, the hope is that the fight against coronavirus will transpire into a successful global response to climate change.
The World In A Week – Interim Update
We knew it was coming, but that did not stop the market from overreacting to what is undeniably a certainty.
The UK economy shrank at the fastest monthly rate on record during March, due to the lockdown and the enforced economic slowdown. UK gross domestic product (GDP) fell 5.8% compared with the previous month, making it the largest drop since records of monthly GDP began in 1997.
It also meant that the UK has had its first quarter-on-quarter drop in GDP since the Global Financial Crisis. The 2% fall compares to falls of 1.2% for the US and 3.8% for the Eurozone. The recession will technically become official when we have a negative reading for this quarter, as you need two consecutive negative quarters for a recession.
Although much of this was widely expected, it did not stop the market reacting wildly. The first three days of this week saw the FTSE 100 swing more than 200 points, evidencing that volatility is here to stay. As we wrote on Monday, the likelihood of a ‘V’ shaped recovery has dissipated, and our base case of a ‘W’ shaped market is looking more probable.
That means more commitments of economic stimulus if markets became too unruly. In anticipation of this, we have already had proposals from the US of an additional $3 trillion fiscal package. However, there is a conflict building between those who see these extreme measures as absolutely necessary, and those that fear the spectre of rising debt will come back to haunt us. Exceptional times call for exceptional measures and ultimately the combined total of the global promises is essential to combat the global pandemic.
The World In A Week - Phoney War
Last week saw a moderate rise in the value of risk assets with the FTSE All Share up +0.65% and the MSCI All Country World Index down -0.36% in GBP terms, as the value of Sterling rose against the Dollar and many other major currencies. Within Equities, the Emerging Markets and Europe lead the way, while Japanese Equities lagged.
This sentiment was also broadly reflected in Fixed Income markets, Investment Grade Credit, High Yield Bonds and Emerging Market Debt all advanced – while Treasury returns were more subdued.
The relative tranquillity observed in markets was at odds with the slew of dreadful economic news that hit the headlines last week. It was announced that the US economy lost 20.5m jobs in April, rocketing the unemployment rate to 14.7% - a new post-war high. Consensus is now gathering that the likelihood of a “V shaped” recovery from the coronavirus is getting closer to zero. The unprecedented increases in unemployment are likely to take a long time to unwind, and consumer’s purchasing power and habits may well be changed for good.
However, since their nadir on the 23rd March 2020, Equity markets have paid little heed to the deteriorating economic fundamentals, with MSCI ACWI up +18.2% and the S&P 500 up +21% in GBP terms. In the riskier Fixed Income markets, we have also seen a strong rally in High Yield Bonds from their lows, although this is arguably not as over-extended as the Equity markets. As we celebrated Victory in Europe Day over the Bank Holiday weekend, it has begun to feel like a phoney war mentality has taken over the markets – one that may collide with reality in due course. While the rally demonstrates the necessity of maintaining market exposure through all stages of a cycle, we remain neutral on Equities at this point.
The World In A Week – Interim Update
A week that has been punctuated by uncertainty and conjecture. As we get to the end of the second three-week lockdown period in the UK, headlines are full of rumour. No one knows what the effect of easing the restrictions will be, and as we have written previously, fear is one of the biggest dangers to the economy.
The economics of ending a lockdown seem to depend on fear and confidence. Consumers need to have assurance around the security of their jobs and feel safe about their risks to their health. If that scenario occurs, then there is the likelihood of consumers spending that short-term pent-up demand.
The balancing act is all about the timing. Too soon and the conditions mentioned above will fail and the potential short-term economic bounce will be snuffed out. That is the tightrope politicians are walking; managing the populations’ expectations, with as light touch as possible around social control, while knowing the longer the delay, means the longer the overall economic recovery.
Meanwhile, the Bank of England has left policy unchanged at their meeting yesterday. Whilst the committee voted unanimously to maintain interest rates at 0.1%, there was also a majority vote of 7-2 to continue with the programme of purchasing £200 billion of UK government bonds and non-financial investment grade corporate bonds. The two members who dissented were actually looking to increase the purchases by an additional £100 billion. A reminder that central bank policy around the world is still firmly in supportive mode.
The World In A Week - The End Of The Beginning
Boris Johnson returned to no. 10 in full capacity last week after successfully defeating the coronavirus. Boris returns to a torn party, split by those in favour of easing lockdown restrictions and those that believe lockdown restrictions should remain in place for longer. Clarity was provided as the week progressed with indications that lockdown measures will be eased, although to what extent, is currently unknown. Boris has promised to outline a ‘comprehensive’ plan of how we will move out of lockdown on Thursday; media speculation is already underway with the primary focus on allowing individuals to choose up to 10 people to include in their social circle.
In a further blow to income investors, UK dividend cuts continued to gather pace. FTSE 100 constituent, Shell, stunned investors by cutting its quarterly dividend by 66% following the collapse in global oil demand and the virus pandemic. The UK dividend market is a key component in global equity income portfolios and given the pace of dividend cuts across the UK market, will put global equity income managers under pressure, with many expected to miss their yield objectives. Income has been a key area of focus for the Investment team and we are finding other areas of opportunity. Asia, an area not typically associated with income, has proved an interesting hunting ground, the region has a lower payout ratio but fewer dividend cuts are expected. Infrastructure is also another area of interest; the sector typically yields between 4-5% and is expected to provide an element of protection in a downturn.
In Europe, the ECB made no changes to interest rates last Thursday but emphasised they remain poised to increase stimulus if needed. The eurozone is expected to be one of the areas hardest hit and will likely suffer a deep recession. While the ECB has confirmed it will do ‘whatever it takes’ to support the euro area, should the current daily pace at which the ECB is buying government bonds continue, the program will reach its limit in October. Last month, the ECB reduced costs for commercial banks to support lending activity and last week, said it would reduce these interest rates further to -1% - effectively paying them to borrow money. Data in the region published on the same day, revealed that the economy had contracted by 3.8% in the first quarter, an all-time low since records began in 1995.
The World In A Week – Interim Update
US GDP fell 1.2% quarter-on-quarter; however, you may have seen the media run with headlines that stated growth falling by 4.8%. It seems pointless to annualise the data at this point, as one thing is almost certain; the next quarter will be a very different number.
There was no movement from the Federal Reserve, who held their Federal Open Market Committee meeting yesterday. They have already committed to do whatever it takes and the drop in GDP was fully expected, which was reiterated in Jerome Powell’s rhetoric.
Expectations are increasing on what the easing of the lockdown measures will look like in reality. Several European countries have already given broad indications of when the easing will begin. Preparations are apparently underway for the UK Government to issue detailed guidance on how Britain can safely go back to work.
Boris Johnson, after celebrating the birth of his son yesterday, is today expected to announce that the coronavirus is being contained, but that it is not yet time to lift the restrictions. Concern is about lifting the lockdown measures too early and run the real risk of a second spike of infections. Silver linings and management of expectations for the public is key at this moment.
The World In A Week - Balancing Act
The focus last week was mainly on the US, which is arguably seen as the new epicentre for the pandemic and, perhaps, the road map for the next phase in this battle.
US equities recorded their first weekly drop in April, illustrating a volatile week that saw indices buffeted by record unemployment claims, disappointing drug trials and an oil price that went negative. The week did end strongly though, as sentiment was lifted by the authorising of the fourth US economic relief package since the pandemic began.
President Trump signed off the $484 billion stimulus package into law, which aims to provide additional relief to small businesses, as well as hospitals, with the aim of increasing coronavirus testing. Never one to miss an opportunity to tweet, Trump also promoted the theory of pent-up demand on his Twitter feed; people in lockdown are generally spending less, meaning enforced savings, and it is those savings that could support a bounce back when the lockdown is lifted, as long as fear is contained.
Trump has also signalled support for ‘reopening’ in his Twitter feed, coinciding with the US state of Georgia, which has rolled back some of the lockdown measures, allowing small businesses such as hairdressers, spas and tattoo parlours to reopen. It also emphasises the dilemma of how social distancing will work at this interim stage, as all of the above businesses involve close contact.
The dichotomy of wanting to supply a service, to keep your business solvent, but at the same time wanting to keep your family safe through social distancing, is another challenge for people and governments to find a solution and tackle the fear of risk. If reopening is enacted too early, or people believe it is too early, fear of the virus could do more economic damage.
The next stage is a difficult balancing act of keeping the population safe, whilst managing people’s expectations for when the lockdown measures could be relaxed. Governments will want to restart their economies as soon as possible but acting too early could be worse than acting too late.
The World In A Week – Interim Update
There is always an anomaly that appears during a crisis to disrupt markets or economies to an extreme, and the COVID-19 crisis is no exception. Rising production and collapsing demand, due to a deliberate policy of an economic shutdown, is causing an unprecedented glut in the oil market. This has sent oil prices for West Texas Intermediate (WTI) to a multi-year low, which reached negative at one point.
Travel restrictions, due to social distancing stay-at-home sanctions, have reduced the global demand for oil by an estimated 5.6 million barrels per day (mb/d). Research conducted by BP shows that almost 58% of global oil demand is derived from fuel for transportation. This makes the current situation much worse than a normal recession because of the widespread implementation of travel restrictions.
This problem has been brewing for a while, with Russia and Saudi Arabia unable to agree on production cuts in early March. This caused a bizarre situation in which Saudi Arabia actually increased production and sparked a price war. The main oil producers gathered around the table at Easter and agreed to an historic cut in production to contain the oil glut. Production will be cut by 9.7 mb/d starting on 1st May. Cuts will begin to taper each month to 5.6 mb/d by the end of the year.
Despite the historic significance of the agreement, the agreed cuts do not appear to be aggressive enough to balance the large drop in demand. Oil inventories are likely to continue to rise in the short term, with storage facilities at capacity; this is putting further pressure on oil prices.
The anomaly of negative oil prices happened this week, with the May contract for oil delivery, for WTI, falling as low as -$40 a barrel. The situation was created by holders of the oil contracts having to pay to have the oil taken away and stored. Global storage of oil is almost at capacity, which increases the prices to have the commodity stored. This price of storage exceeded the actual price of the oil itself, thereby creating a negative contract.
This volatility in oil prices has spilled over into other asset classes, with global equities feeling the pressure. It is likely that the distortions we are seeing in the oil market will contribute to volatility in other asset classes, in the short term. However, it is expected that this period of extreme dislocation will dissipate in the second half of the year, as travel restrictions are gradually relaxed. So, while oil could contribute to volatility in equities and fixed income over the coming months, we do not expect it to become a major driver.
The World In A Week - Crunch Time
Tensions are running high. The balance between keeping economies locked down in order to protect the health services, and the desire to loosen lockdown measures in order to lessen the long-term impacts, is coming to a head.
Here in the UK, there has been tentative rhetoric that we are preparing to lift restrictions, but attention has shifted towards accusations that Boris Johnson’s senior aide broke lockdown rules. All nations will need unity to help with smoothing the economics of a bounce back, and Dominic Cummings’ actions will certainly be an unwelcome spanner in the planning.
In the US, we have already commented on the increasing pressures between itself and China, mainly at the finger of Trump’s Twitter account. Over the weekend, it was the turn of China’s foreign minister to ratchet up the tension, accusing the US of pushing relations to a New Cold War. All of this could mean short-term volatility in financial markets.
However, support for markets from both central banks and governments remains significant. Last week, France and Germany proposed a €500 billion Recovery Fund that would represent a significant step towards fiscal mutualisation in the Eurozone. What does this mean? The idea is that the distribution of the Fund’s resources will be based on need, while the burden of the repayment will be based on ability. This will treat the Eurozone as a whole, with the arguably stronger nations, such as France and Germany taking on greater burden, while less well-off nations, such as Italy and Spain, can benefit from the resources of the Fund.
We knew the route to combat COVID-19 would be uncertain and we appear to be at another inflection point. While the short term remains unclear for markets, the monetary and fiscal support appears to be the one constant.