Affinity Market Commentary – October 2020

Election jitters add to uncertainty in US equities

US Equities had seemingly moved to discount a Democratic win in the November election, but repeated threats from President Trump to challenge any result that did not favour him, sent ripples around the markets, with fears that the election on 3rd November, might not be fully resolved any time soon. The roll-over in technology shares continued as investors took profits from the parts of the market that have seen the biggest

Covid-19 second wave hits Europe

Once again, the UK and EU markets performed poorly, as Covid-19 case numbers began to increase rapidly, and lockdowns were introduced across several cities and regions, culminating in whole countries heading into lockdown by the end of the month. France and Germany and Belgium were fully locked down as at 31st October, with the UK expected to announce similar measures within a few days.

Merkel sees a Brexit agreement as “overwhelmingly unlikely”

The outlook for the UK and EU economies was further dented in October by an apparent breakdown in talks between the two parties over a post-Brexit trade deal. Chancellor Merkel told UK representatives that a deal now seemed ‘overwhelmingly unlikely’, whilst the British delegation returned to London and the Prime Minister announced that British businesses should now prepare for an exit on WTO terms.

Asian markets buoyed on Covid and US election

The best equity performance in October came from the Asia ex Japan region, where the two-fold benefits of a more benign experience with Covid-19, and the prospect of more harmonious trade relations between China and the US, following the election of the democrat, Joe Biden, meant that the region produced the only decent gain to be had across the global equity landscape.

 

It is said that when America sneezes, the rest of the world catches a cold. This was certainly true in October, as investors became jittery ahead of the US presidential election, and technology stocks, which have led the market upwards for most of this year, fell prey to further profit-taking, adding to losses from the previous month. This was exacerbated by growing fears for the global economy, as many countries saw a resurgence in Covi-19 cases, and began to implement a second terms. Angela Merkel also stated that a deal now looks ‘overwhelmingly unlikely’.

 

The Yen was once again the currency of choice for nervous investors during November. As many commentators had suggested, the rally in the dollar was not sustained, and the US currency lost ground against the pound and the euro. The euro continued to benefit from the reversal of the ‘carry trade’, which had seen investors buying the higher-yielding dollar, and selling the negative-yielding euro. However, the gap between EU and US rates has narrowed considerably, making the trade considerably less attractive, and resulting in flows back out of the dollar and into the euro.

 

Most of the world saw yields rising during November, as bonds globally came under selling pressure, along with equities. In Europe, however, yields generally contracted, as investors moved from the US fixed income market to the EU, based on a contraction in the rate differential between the two markets (see also the currency comments above). Eurozone ten-year bonds reached -0.63%; close to their low of c.-0.70%.
*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.

 

Taking Stock – Market Performance Review

Leaving aside the outstanding legal challenges from President Trump, it appears that the US election has now produced a result, and we expect Joe Biden to take up residence in the Whitehouse in January. In 2016, Donald Trump, at 70, edged out Ronald Reagan as the oldest man to become president. Joe Biden will be 78, which must leave a question mark over whether two terms will be a realistic possibility. However, it appears that, for the moment, we have a degree of certainty and stability in US politics. Democrats took the House of Representatives, and will have control for another two years. It seems unlikely, at this stage, that they will win the Senate.

Whilst it is early to speculate about what President Elect Biden will be able or willing to do, we should expect a more engaged stance with environmental issues – good for renewable energy, a higher priority for Covid-19 – good for healthcare, and a more aggressive attitude to big tech, involving higher taxes and/or tougher regulation. Overall, international trade will be likely to improve, as Biden will be expected to ease tensions, rather than stoking them.

It has been a theme of our output over the past six months that technology has led a very narrow recovery in the US market since the bottom of the spring collapse. During the period from 31st March to 30th September, the information technology sector in the US has been the stand-out winner, whilst other sectors have fared much less well – some even returning losses. Financials, which often constitute a major part of equity portfolios, whilst returning a gain, have been a noticeable laggard:

 

In October, however, after a very strong recovery, markets began to falter, as the US election began to dominate the thinking of investors. A recommendation from Goldman Sachs on 16th October, to ‘temporarily’ rotate out of technology into banks and autos, added to the profit-taking that was already being seen in the tech sector. Over the month of October, financials came to the fore and achieved a small gain, against the backdrop of a falling market, and technology stocks clearly starting to roll over:

 

After an extended period of strong returns from the US technology giants, which has seen many of them rise to very high valuations (Apple reached a market cap of over $2tr), the prospect of a democratic president and possibly Congress, led many investors to focus on the possibility of increased taxation and/or regulation for the technology companies.

Utilities, healthcare and industrials have also bucked the market trend. Since the market reached its low point back in March, we have increased exposure to the small and mid-cap areas of the US market, taking the emphasis off the mega-cap stocks.

In addition to pre-election uncertainty, growing Covid-19 case numbers and a lack of progress in negotiations between republicans and democrats over a new Covid-19 relief plan have also contributed to a more cautious tone among investors. This may well be just a short pause in the market’s recovery; the University of Michigan’s consumer confidence index rose from 80.4 in September to 81.2 in October, and this was confirmed by a 1.9% rise in US retail sales in September (vs 0.7% forecast), following a rise of 0.6% in August. Excluding autos, the September figure was +1.5% (vs 0.4% forecast). The ISM number, measuring manufacturing activity, also accelerated in October to 59.3, this followed a reading of 55.4 in September; its highest level since November 2018.

All of this optimism, however, belies the more mixed tone of the broader spectrum of economic data. The US budget deficit has reached an eye-watering $3.132tr; three times higher than the $984bn seen in 2019. Oil demand remains in doubt, as many countries are already reintroducing total or partial lockdowns. Whilst Hurricane Delta shut down almost all oil production in the Gulf of Mexico, facilities have returned to production faster than expected, and the price of the US benchmark WTI stands around $35; c.43% down from its price at the start of the year.

Our signals have also become more positive on Japan, and the wider Asia region. We have maintained exposure to Japan for some time, favouring more new-economy, technology-led funds wherever possible. The market took the recent change of prime minister in its stride, with investors seeing it as representing a continuation of policy, with the prospect of some new ideas in due course. Over the past six months, Japanese equities have provided the best return of the major markets, slightly ahead of US equities, and considerably ahead of the UK and Europe. They have done this with lower volatility and a more benign drawdown experience, whilst also providing a small currency gain, as the Yen has once again been seen as a safe haven in times of turmoil:
Source:

 

UK equities, as can be seen from this chart, have continued to flounder during the recovery, as they did in the collapse. With Brexit worries once again coming to the surface, and the nation entering a second Covid-19 lockdown, investors have little confidence, and our bold decision to pull out of our home market entirely earlier in the year, has proven to be exactly the right course of action.

Another recent re-introduction to portfolios has been emerging market equities. As global markets have experienced heightened volatility this year, emerging market equities have presented a higher level of risk than was apparently being rewarded. The emerging markets are attractive because they have high growth rates, which could allow them to recover more quickly from the economic damage from Covid-19. These higher growth rates, however, are largely fuelled by US dollar-denominated debt, and this makes the markets very sensitive to shifts in the dollar exchange rate, with a strong dollar being negative for emerging markets. Having added emerging market exposure to many portfolios in October, we have already seen the MSCI Emerging Market index gain almost 4% against the more general FTSE World Index.

During the course of the year, we have also been active in seeking new ways to provide protection and defence within portfolios, and to this end, we have moved more heavily into short-dated bond funds. After initially bouncing strongly from the trough of the market in March, bonds have recently been more mixed due to a number of economic imponderables. In the US, the republicans and democrats have been unable to come to an agreement on a further US stimulus package. Central bank monetary stimulus packages have supported market liquidity and have come to be relied upon by investors, but these have done little to support employees or companies that are facing bankruptcy following pandemic restrictions. The next phase needs to be a fiscal stimulus, aimed at Main Street, rather than Wall Street. The problem is that, with a rapidly growing pile of debt and massive deficits already, there is limited room for governments to manoeuvre. Hence very mixed signals and uncertainty for bond market investors.

The changes this year have seen a strong performance from the model portfolios, and laid the groundwork for continuing participation in the global recovery, whilst, at the same time, continuing to avoid the value traps that are still in evidence.

 

Disclaimer: The information contained in this report is for illustrative purposes only and should not be construed as a solicitation nor offer, nor recommendation to acquire or dispose of any investment. Specifically, the share class used to create the illustrations may not be available on all platforms nor be suitable for individual investors. This report was produced by Collidr Research (“Collidr”) for Affinity Integrated Wealth Management (AIWM) and while AIWM and Collidr use reasonable efforts to obtain information from sources which they believe to be reliable, neither AIWM nor Collidr make any representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are subject to change without notice. Model returns are calculated using the most appropriate share class of the underlying funds, having regard to the illustrative nature of the report, with all income being reinvested. As a result, real portfolio performance may vary from model performance. Where model portfolio histories are shorter than three years, historic model returns are substituted prior to inception date with returns from an Collidr performance benchmark. This benchmark is constructed from the average returns of all Collidr portfolios with similar risk profiles that existed during that time. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. Affinity Integrated Wealth Management is a trading style of Buryfield Grange Limited, Buryfield Grange Life Planning Limited and Affinity Integrated Wealth Management Ltd. ‘Buryfield Grange Limited’ is authorised and regulated by The Financial Conduct Authority. Not all services provided by Buryfield Grange are regulated by the Financial Conduct Authority. ‘Buryfield Grange Limited’ is registered in England and Wales at Inspire House, 20 Tonbridge Road, Maidstone, Kent, ME16 8RT. Company registration number 4568338. Collidr Research is a trading name of Collidr Technologies Limited, registered in England and Wales at 34 Southwark Bridge Road, London, SE1 9EU. Company registration number 09061794. Data Providers: Bloomberg L.P. and Collidr.