If there is one thing equity markets are good at, it’s being able to see beyond the here and now. Which explains why markets crashed well before cases of Covid-19 had peaked in Europe and the US. Investors extrapolated what could happen, but were unable to assess the impact, hence the panic and subsequent sell-off. Now markets are calmer as they look beyond the immediate impact of Covid-19 and can model the likely range of outcomes.
Coming to terms with the new economic landscape
As you can see from the graph below, global equity markets have staged a remarkable comeback over recent weeks, recovering almost half of their losses. We’re getting a clearer view of the impact of Covid-19 on businesses, and investors are able to make better informed decisions on the likely winners and losers.
“Although the extreme panic of March has moderated, markets are still volatile due to uncertainty around when economies can return to normal. We’re now getting a good level of understanding of how different businesses will be affected by recent events, which makes it easier to identify the potential winners and losers.” - Philip Smeaton, Chief Investment Officer
Equity valuations have increased, which means buying opportunities are not as prolific as they were. We decided to ‘bank’ some of the gains we made in recent weeks and have returned to a neutral stance on equities as a result.
Clearly, the global economy is not out of the woods yet, and while we don’t expect markets to revisit the lows of March, there is a lot for investors to come to terms with. There may well be aftershocks yet to come, but we see these as buying opportunities, and our focus going forward will be on careful stock picking.
We favour growth stocks, such as technology companies and other businesses that can take advantage of the new landscape. We also favour defensive stocks, which are stable businesses with strong balance sheets and critical products that the market needs. Finally, we look for opportunities in slightly riskier stocks that remain ‘cheap’ (such as certain travel companies) but are likely to be the ultimate winners in their sector.
Investment View: The long-term impact of quantitative easing
Back in 2008 – amid the global banking crisis – governments around the world were forced to embark on large scale quantitative-easing programmes, from which their balance sheets never recovered. So, as the US embarks on a rescue package that dwarfs that of 2008, and the UK writes a blank cheque to support the economy and those out of work, it’s understandable people are feeling nervous about what that will mean for us all in the long run.
Since March, the US House of Representatives has passed nearly $3 trillion in economic stimulus. Meanwhile, the UK’s public sector borrowing reached £62 billion in April – an increase of £51 billion on the same month last year. And latest estimates suggest that Chancellor Rishi Sunak’s business loans and furlough schemes could cost the country £300 billion by the end of this year.
Desperate times call for desperate measures
While these numbers are eye-wateringly high, they are a necessary response to the paralysis of the global economy. Not even the Great Depression or the Spanish flu saw unemployment in the US rise so sharply in such a short space of time (see chart 1), while tax revenues decreased equally dramatically. In April, UK tax receipts were down almost £26 billion compared to the same time last year, according to figures released by HM Revenue & Customs.
Chart 1: US jobless claims, May 2020
Lend money to create money
Current levels of quantitative easing are now dwarfing that of the credit crisis (see chart 2). New money is being created by central banks as they purchase assets, and the banking system is taking that money and multiplying it through loans to consumers and corporations.
Only time will tell if this strategy works. It certainly rescued the global economy from the credit crisis, but interest rates have remained very low since then. If they are forced to increase in the future, such unprecedented levels of debt will undoubtedly come home to roost.
Chart 2: QE Effect on US balance sheet
The risk of inflation
As the US and UK spend far more than they are taking in taxes, they are running up a considerable budget deficit, which when financed by printing money is one of the pre-cursors of inflation. Combine that with uncertainty in China, whose cheap production of goods has been a key factor in keeping the price of consumer goods low in the UK, and we believe inflation (and therefore rising interest rates) is one of the biggest risks facing the global economy. Perhaps not in the short term, but certainly in the future. While it is good for reducing debt levels, this will be painful for businesses, consumers and investors.
The good news is that financial markets are not yet pricing in the risk of inflation, which means we are able to buy inflation-linked bonds at a good price, thus protecting portfolios without having to pay through the nose for it.
Intuitively, it feels like we will need to pay for this stimulus at some point in the future – whether it’s through increased taxes, long-term austerity or both. For now, how governments intend to redress the balance is up for debate. As investors, all we can do is ensure we are assessing the risks at large and taking steps to protect our investors for both the short- and long-term implications of this global crisis.
The information and opinion contained in this Monthly Commentary should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed are based on information received from a variety of sources which we believe to be reliable but are not guaranteed as to accuracy or completeness by Sanlam. Any expressions of opinion are subject to change without notice. Past performance is not a reliable indicator of future results. Investing involves risk and the value of investments, and the income from them, may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.