The Kingswood Investment Podcast

The equity market rally paused last week with global equities little changed in local currency terms. Even so, this still leaves markets up a hefty 10% so far this month with UK equities gaining as much as 14%.

The November rally started with the US election results but gathered momentum with the recent very encouraging vaccine news. This continued today with the AstraZeneca/Oxford vaccine proving to be up to 90% effective in preventing Covid infections. This is slightly below the 95% efficacy of the Pfizer and Moderna vaccines already reported but this one has the advantage of not needing to be stored at ultra-cold temperatures. One or more of these vaccines now looks very likely to start being rolled out within a few weeks.

Of course, these vaccines will do little to halt the current surge in infections. Cases may now be starting to moderate in the UK and some countries in Europe but the trend remains sharply upwards in the US. The damage lockdowns are doing to the recovery was highlighted today with the news that business confidence in the UK and Europe fell back into recessionary territory in November.

Markets, however, are likely to continue to look through this weakness to the prospect of a strong global recovery next year. While equities may have little additional upside near term, they should see further significant gains next year. Their current high valuations should be supported by the very low level of interest rates, leaving a rebound in earnings to drive markets higher.

Prospective returns over the coming year look markedly higher for equities than for bonds, where return prospects are very limited. As for the downside risks for equities, they appear much reduced with the recent vaccine news and central banks making it clear they are still intent on doing all they can to support growth.

Both factors mean we have taken the decision to increase our equity exposure. While our portfolios already have significant allocations to equities and have benefited from the rally in recent months, we are now moving our allocations into line with the levels we would expect to hold over the long term.

Our new equity allocations will be focused on the ‘value’ areas of the market. The last few weeks have seen a significant rotation out of expensive high ‘growth’ sectors such as technology into cheaper and more cyclical areas such as financials, materials and industrials. Similarly, countries and regions, such as the UK which look particularly cheap, have fared well just recently.

We think this rotation has further to run and will be adding to our UK exposure. This does not mean we have suddenly become converts to Boris’s rose-tinted post-Brexit view of the UK’s economic prospects. Instead, this more favourable backdrop for cheap markets is likely to favour the UK.

We will also be adding to US equities. Again, this does not represent a change in our longstanding caution on the US market overall due to its high valuation. Rather, we will be investing in the cheaper areas of the US which have significant catch-up potential.

We are also making a change to our Asia ex Japan equity holdings. We will be focusing some of this exposure on China which we believe deserves a specific allocation due to the strong performance of late of that economy and the sheer size of the Chinese equity market.

On the fixed income side, we will be reducing our allocation to short maturity high quality UK corporate bonds, where return prospects look particularly limited. We are also taking the opportunity to add an allocation to inflation-linked bonds in our lower risk, fixed income heavy, portfolios. These have little protection against a rise in inflation unlike our higher risk portfolios, which are protected through their equity holdings.

Global equities bounced close to 7% last week, more than reversing their 5% decline the previous week. They opened up another 1.5% this morning and were testing their all-time highs even before the positive vaccine news gave them another 3-4% boost.

So why the euphoria on the back of the US election results? After all, Biden’s victory was not exactly a big surprise – he was the firm favourite going into the election.

First and most important: markets like certainty. The worst case scenario of a close result with weeks of uncertainty seems to have been avoided. Trump may well continue to dispute the result but his legal challenges look very unlikely to succeed with Biden’s margin of victory large enough not to be overturned in any re-counts.

The one thing a Biden Presidency can surely be guaranteed to bring is more stability, particularly in foreign policy. This is all the more the case now as the prospect is for a divided government which will severely limit his ability to implement the more radical elements of his policy program.

Indeed, the real surprise was not Biden’s victory but that the clean sweep by the Democrats, which markets had increasingly been pricing in, failed to materialise. The Democrat majority in the House of Representatives was reduced and the Republicans look likely to retain control of the Senate. The latter will only be confirmed on 5 January when there is a re-run of the election of Georgia’s two senators.

Biden’s policies always contained a mixture of the good and the bad as far as markets were concerned. The good included his plans for a major fiscal stimulus while the bad included higher taxes on corporations and more regulation. Action in both areas should now be limited. On the fiscal front, a stimulus package will probably still be agreed in the next couple of months but will be half the size it would have been with a clean sweep.

At the end of the day as ever, market prospects from here will be driven by the economic outlook. While the US recovery has been stronger than expected, the rapid rise in infections now being seen mean it still faces significant challenges. The Biden Government’s Covid policy can only be an improvement but Biden is not inaugurated until 20 January and a big fiscal boost is no longer on the cards.

Today’s news that Pfizer and BioNTEch’s vaccine is effective in preventing 90% of people from contracting Covid-19 is clearly a major step forward but it is not a silver bullet. A mass roll-out of vaccines was always going to take time and logistical issues can only be increased by the need to store the vaccine at ultra-cold temperatures. It is also far from clear what proportion of the population will be willing to be vaccinated and how long immunity will last.

Back here in the UK, the authorities took action last week to limit the hit to the economy from the new lockdown. Amongst other measures, the furlough scheme was extended to March at an estimated cost of around £6bn per month and the Bank of England boosted its quantitative easing program by £150bn to £895bn. This will allow it to remain a major buyer of gilts through next year.

Even so, the Bank has revised down its growth forecasts and is now forecasting the UK economy to contract again in the fourth quarter. The Eurozone economy also faces a double-dip recession with lockdowns in place in a number of countries. The near-term economic outlook therefore remains challenging in the UK, Europe and the US. As yet, it only seems to be China which has a secure recovery under its belt.

Today’s vaccine news does make it all the more likely that economies outside China resume their recovery in the new year as vaccines start to be rolled out. This in turn should set the scene for further gains in equities. Near term, however, with equities currently now up as much as 12% in little more than a week and valuations at twenty year highs, the good news seems very much priced in.

Global equities took a tumble last week, losing 5.0% in local currency terms. This left markets down some 7% from their early September high but still leaves them up some 40% from their March low.

The reason for the sell-off is not hard to fathom, namely the surge in infections in the UK and Europe and the new lockdowns announced both here and in countries such as France and Germany. 

Lockdown 2.0 is not as severe as its predecessor but will still deal a significant blow to economic activity. The Eurozone and the US last week may both have announced record growth in the third quarter, but GDP remained a sizeable 4.3% and 3.5% respectively down on the end of last year. The latest lockdowns now threaten a renewed decline in Europe in the fourth quarter.

The UK hasn’t released Q3 numbers as yet, but as of August, GDP was as much as 9.0% below its end-2019 level. It has been one of the economies worst hit by Covid and remains one of the most vulnerable. Even though Rishi Sunak has now reinstated the more generous furlough scheme, the lockdown risks reducing GDP by a hefty 5% or so in the fourth quarter.

The US also looks likely to see growth suffer over coming months with infections climbing sharply and the government response chaotic. Only in China is Covid already beginning to seem like a distant nightmare with GDP up 4.1% this year. This divergence has been reflected in the marked outperformance of the Chinese stock market year-to-date, which continued last week with it down only a modest 0.5%.

While the next couple of months could well see further market weakness, we do not expect anything like a re-run of the sell-off earlier in the year. The lockdowns are less severe, the hit to GDP should be much smaller and we are rather closer to seeing light at the end of the tunnel. Much more extensive testing, better treatments and vaccine roll-outs should all lead to the picture steadily improving through next year and in time provide the rationale for further gains in equities.

In the meantime, one source of support is coming from earnings. We are now over half-way through the Q3 reporting season in the US and earnings are coming in considerably better than expected. The tech giants reported last week and generally beat expectations (not that it did their share prices much good) as did the banks earlier in the month. S&P 500 earnings now look likely to fall some 10% rather than 20% as was the expectation at the start of reporting. 

Still, markets near term have not only to contend with Covid but also the US elections. We will keep our comments brief today. So much has already been written on the subject and, with the result still uncertain, it makes sense to wait until the dust has settled before pontificating any further at any length. It should also not be forgotten at times such as these that the importance of the US election in driving markets is often exaggerated. More important generally than which party wins the election is the state of the business cycle, Fed policy and also this time, of course, Covid. 

What can be said with any confidence is limited. Biden remains the front runner but his victory is far from assured. The worst outcome for markets would be a close and contested vote which might not see the victor announced for weeks. As for the best outcome, other than a clear victory by either candidate, it is far from clear. Biden’s policies are a very mixed bag and the ability of Trump or Biden to implement their policies will depend on winning control of Congress. 

We will be sending out a post-election update on Wednesday by which time we may, or may not, be able to shed some further light on these matters.

Last week was a relatively quiet one for markets, with global equities ending 0.4% lower in local currency terms. Coming weeks, however, look set to be a rather more lively affair with several key areas of uncertainty being resolved one way or the other, or not.

The first major uncertainty and area of concern relates to the second wave of infections and social distancing restrictions now being introduced in the UK and much of Europe. This poses a threat to the economic recovery which was already showing signs of slowing. Indeed, business confidence retreated in October with the services sector driving the decline.

Here in the UK, the Chancellor has been forced into a major expansion of the job support scheme which takes over from the furlough scheme in November. There was also more help announced for the self-employed and businesses affected by Tier 2 restrictions. In total, these measures could cost a sizeable £15bn or so and the budget deficit this year now looks likely to end up a whopping £350bn or 17% of GDP - or possibly even more.

With infections still continuing to climb, the effectiveness of the new restrictions far from clear and the timing of any vaccine roll-out still up in the air, the virus clearly remains a wild-card for markets.

So too do the US elections on 3 November. Biden continues to have a significant 9% lead in the polls and the betting markets currently give him a two in three chance of victory. Still, it remains far from a done deal with the battle in some of the key swing states tight. Moreover, control of the Senate, which will be critical in determining to what extent Biden can implement his agenda, is even more of a close call.

The market’s preferred outcome seems to be for a clean sweep by the Democrats which will allow the implementation of a sizeable fiscal stimulus. If by contrast, there were split control of the Presidency and Congress, this would effectively lead to a continuation of the status quo with divided government a major constraint on new policies. Worst of all, however, would be a close and contested result with possibly weeks of rancour and confusion in prospect.

Then there is Brexit, where the prognosis is as unclear as ever. Talks were called off the weekend before last but are now back on. The only thing certain is that crunch time is approaching rapidly.

One final source of uncertainty relates to valuations which have been the main factor driving this year’s violent swing in equity markets. The 2-year forward-looking price-earnings ratio for global equities was 17x back in February, collapsed to 10x at the market low in March, only to rebound to 19x now - the highest level in twenty years.

This would set alarm bells ringing if interest rates were not at unprecedentedly low levels and equities did not still look reasonably valued against bonds. While we believe current valuations should be sustainable with no hike in rates likely any time soon, they leave little room for error.

All this leaves the markets facing an uncertain time over the next couple of months. In the new year, however, equities should have scope for further gains if, as seems likely, vaccines start to be rolled out, bringing the prospect of a slow return to quasi-normality.

Global equities overall ended last week little changed but this concealed significant differences in performance between regions. Chinese stocks rose 2.6% in sterling terms while the US gained 0.7% and the UK declined 1.5%. This continues a trend very much in evidence already this year – China is up 25% year-to-date while the US up 12% and the UK is down 19%.

This dramatic divergence is not hard to explain. The Chinese economy has suffered much less from the pandemic than most others. This was confirmed this morning with the latest crop of economic releases which showed Chinese activity almost back to normal. GDP was up 4.9% in Q3 on a year earlier – by contrast, UK GDP in August was still down 9.2% on the previous year.

As for the US economy, it hasn’t fared half as well as China but hasn’t been hit half as badly as the UK. Despite the failure to agree a new fiscal stimulus, recent data show the US recovery continues with retail sales posting a sizeable, and larger than expected, rise in September.

The Q3 results of the big US banks last week backed this up. Their earnings beat expectations, partly because of a surge in trading revenues but also because of reduced loan loss charges as the economy hasn’t performed as badly as feared.

The US elections remain a major focus. The markets seem to have taken a liking to the idea of a Biden victory and possible clean sweep by the Democrats because it would lead to a sizeable fiscal boost. However, this result is still not a done deal with the betting odds of a Biden victory narrowing back down to 60% from 65% a week ago. The final Presidential ‘debate’ on Thursday may be Trump’s last chance to narrow the polls which still favour Biden.

Back closer to home, the economic picture for Europe looks rather grimmer. The spike in infections is leading to a wave of new social distancing/localised lockdown measures and there is now talk that this could even trigger a double-dip recession.

Here in the UK, we not only have to contend with new lockdown measures but also Brexit. Last week had been billed as critical with the EU Summit and Boris’s 15 October deadline for the guts of a deal to be agreed. However, somewhat unsurprisingly, a week later and we are not much the wiser.

Boris has now officially broken off trade talks…unless the EU comes back with concessions. This still clearly leaves the door open for a compromise to be reached despite the bluster to the contrary. That certainly appears to be the way the currency markets are reading it.

The pound in the past has been very sensitive to the changing odds of a Deal or No-Deal but last week it hardly moved. If we do end up with No-Deal, sterling will very likely fall although maybe by not that much as the difference between the two options now on the table – No-Deal or a very minimalist Deal – is not really that large. As regards the continuing underperformance of UK equities, this probably reflects the view that Brexit, whatever form it ends up taking, is the last thing the economic recovery needs right now.

If there is No-Deal, the impact may be more visible in intra-market moves rather than on the market overall. A fall in the pound would provide some protection to the FTSE 100 as around 75% of its revenues come from abroad. These earnings will not be that exposed to the UK economy and be worth rather more in sterling terms. Mid and small cap stocks, by contrast, will be rather more vulnerable. They have a little less than 50% of their earnings coming from overseas and could give back some of their recent outperformance.

All this leaves us continuing to believe that markets are in for a choppy few weeks. They are likely to be buffeted by fast changing news flow on lockdowns, vaccines, the US elections and Brexit.

Last week was a surprisingly good week for equity markets. Global equities gained as much as 3.4% in local currency terms and have now recovered the bulk of their losses in the recent correction.

The latest gains at first sight are puzzling given the shenanigans going on in the White House. Of course, it is possible that markets may simply have taken heart from President Trump bouncing back from Covid, larger than life than ever. But they are not known for their sentimentality.

The explanation is more hard-headed. Far from Trump benefiting from a sympathy vote, his antics have increased Biden’s lead in the polls to close to 10%. The betting markets now give a two in three chance of Biden winning the Presidency.

If there is a clear victory for Biden, this reduces the chances of possibly the worst outcome for the markets – a result which would remain in dispute for a number of weeks after the election. A decisive victory, particularly if it includes the Democrats gaining control of the Senate, would also mean it would be easier for Biden to implement his plans for a sizeable fiscal stimulus package early next year.

The concern recently has been that Congress and the President have failed to agree a package to replace the stimulus measures which expired in July. The position here changed almost daily last week but on balance an agreement still looks unlikely this side of the election. If so, the prospect of a new Democratic Government able to enact an increasingly badly needed fiscal stimulus clearly has its attractions.

Still, one should not forget that Biden’s plans for hikes in corporation tax and the minimum wage and increased regulation are distinctly less market friendly. It still looks very likely the lead up to the election will be a period of volatility for markets.

Back here in the UK, the US has been a distraction from the grim news on infections and lockdowns and the latest downbeat GDP numbers. UK GDP posted a sizeable 2.2% m/m gain in August which in normal times would be cause for celebration. However, the increase was half the size expected and significantly smaller than the gains seen in June and July.

The pace of the recovery has slowed significantly even before renewed social distancing restrictions had started to be imposed. Yet the economy still has a long way to recover with GDP remaining down some 9% from its peak. By comparison, GDP fell around 7% in the Global Financial Crisis.

This gloomy outlook may have some bearing on whether or not we end up with a Brexit deal. The last thing the economy, and indeed the Government, needs is the inevitable disruption that would be caused in the New Year by a No-Deal.

This week will be critical with the Prime Minister adamant that the guts of an agreement need to be sorted out by the EU summit on Thursday. On balance, we believe a minimalist deal will eventually be reached, albeit not by Thursday.

While Brexit and the new lockdown measures will be the centre of attention for the UK this coming week, global markets will be more concerned with the start of the US reporting season for the third quarter. Earnings are forecast to fall a substantial 20% compared with a year ago. However, this is a smaller decline than expected a few weeks ago and the 30% drop seen in the second quarter.

Any further gains in equities over the coming year will very likely need to be driven primarily by earnings gains rather than a further re-rating of valuations. Management guidance will therefore be pored over as closely as ever even if the outlook in reality depends heavily both on the election result and forthcoming vaccine developments.

We warned recently that equity markets were entering choppy waters and last week’s developments can only add to the turbulence.

Equities had started to recover some of their losses in the recent correction but the first of the US Presidential debates and then the news of Trump testing positive for Covid swiftly took centre stage. Equities fell back on Friday only to perk up again this morning.

Biden was widely agreed to have fared better in last week’s debate – not that much debate actually managed to take place. Trump testing positive is more of a wildcard but would also seem to favour Biden. It focuses attention back onto Covid (not Trump’s strong point) and the President’s campaign is now in disarray. Against that, Trump could benefit from a sympathy vote.

Biden has had a consistent lead in the national polls in recent months and is also leading in the key battleground states. He looks considerably better placed than Clinton was four years ago and the betting odds have recently moved significantly in his favour, with his chance of victory now put at 60%.

However, as far as the markets are concerned, the Congressional elections are almost as important as the Presidential election. Currently, the Democrats have a sizeable majority in the House of Representatives but the Republicans have a small majority in the Senate. If as now looks quite possible, the Democrats took the Senate as well as the Presidency, this clean sweep would mean many more of Biden’s policy pledges would be implemented rather than thwarted.

As for the policies themselves, they’re a mixed bag. They include plans to raise the corporate tax rate and minimum wage and for increased regulation – none of which are market friendly. But Biden also plans a sizeable increase in spending on infrastructure, healthcare and education. This would be more positive particularly if it fed into higher growth.

Biden’s approach to foreign policy should also make for less of a roller-coaster ride. Even though US hostility towards China looks certain to continue, his approach is likely to be less impulsive and confrontational than Trump’s.

The impact of last week’s news is complicated by the failure of the federal Government to agree a renewal of the income support measures which expired in July. A deal had become unlikely ahead of the election but, with the fall-out from Covid all too visible once again, this could force a compromise to be reached which would be positive.

One final complication is that this all assumes there is a clear election result. The possibility which is haunting the markets is that the vote is a close-call. The result might then not be established for weeks and Trump may not go quietly with all his talk of electoral fraud due to increased postal votes.

The bottom line is that the US elections have many moving parts and will be a sure source of market volatility over the next month or two. That said, we are not expecting a repeat of anything like the turbulence we saw earlier in the year. At the end of the day, the lesson from history is that Fed policy is generally much more important for markets than Government policy – and the Fed is a centre of stability at the moment with policy firmly on hold.

Equity markets had another choppy week, falling for most of it before recovering some of their losses on Friday and posting further gains this morning.

At their low point last week, global equities were down some 7% from their high in early September. US equities were down close to 10%, hurt by the large weighting to the tech giants which at least initially led the market decline.

The market correction is nothing out of the ordinary with 5-10% declines surprisingly common. Indeed, a set-back was arguably overdue given the size and speed of the market rebound from the low in March.  As to the cause for the latest weakness, it is all too obvious – namely the second wave of infections being seen across the UK and much of Europe and the local lockdowns being imposed as a result.

These will inevitably take their toll on the economic recovery which was always set to slow significantly following an initial strong bounce. Indeed, business confidence fell back in September both here and in Europe with the declines led by the consumer-facing service sector. A further drop looks inevitable in October – fuelled no doubt in the UK by the prospect that the latest restrictions could be in place for as long as six months.

The job support package announced by Rishi Sunak did little to boost confidence. Its aim is to limit the surge in unemployment triggered by the end of the furlough scheme in October. However, the scheme is much less generous than the one it replaces as the government doesn’t want to continue subsidising jobs which are no longer viable longer term.  A rise in the unemployment rate to 8% or so later this year still looks quite likely.

Aside from Covid, for the UK at least, there is of course another major source of uncertainty – namely Brexit. Another round of trade talks starts this week and we are rapidly reaching crunch time with a deal needing to be largely finalised by the end of October.

Whether we end up with one or not is still far from clear. That said, the prospects for a deal maybe look rather better than they did a couple of weeks ago when the Government was busy tearing up parts of the Withdrawal Agreement. With significant Covid restrictions quite probably still in place in the new year and the Government already under attack for incompetence, it may not wish to take the flack for inflicting yet more chaos onto the economy.

Markets remain unimpressed. UK equities underperformed their global counterparts by a further 2.7% last week, bringing the cumulative underperformance to an impressive 24% so far this year. The UK weighting in the global equity index has now shrunk to all of 4.0%.

It is not only the UK which faces a few weeks of uncertainty. The US elections are on 3 November. We also have the first of three Presidential debates this Tuesday. Joe Biden’s lead looks far from unassailable, a close result could be contentious and control of Congress is also up for grabs.

All said and done, equity markets look set for a choppy few weeks. Further out, however, we remain more positive – not least because the focus should hopefully switch from the roll-out of new lockdowns to the roll-out of a vaccine.