A rise in coronavirus infections hit the headlines in the latter stages of July. But despite fears of a second wave, markets were buoyed by the continued stance of policy makers to do ‘whatever it takes’ to keep the economy afloat. Elsewhere, corporate earnings season revealed mixed results, with ‘big tech’ companies proving the big winners.
At the start of the month, we thought July would see significant easing of lockdown measures in the UK and some green shoots of economic recovery, however in the latter half of the month concerns of a potential second wave started to appear in the news. How have the markets reacted?
Lockdown restrictions have begun to ease, not just in the UK, but globally as well. That’s been a huge positive for parts of the economy that rely on physical access or physical interactions, in particular sectors that have until now faced some of the tightest restrictions on activity – hospitality, leisure, travel etc. But it’s the actions of policymakers, corporate earnings and renewed US/China tensions that have tended to move markets in July, rather than Covid cases.
On the policy front, we’ve seen EU leaders agree a symbolic EU recovery fund, that provides for a coordinated EU response that importantly doesn’t add to the debt burden of southern European countries. We’ve also seen the US Federal reserve underline its commitment to its ‘whatever it takes’ policy – extending its domestic lending program and liquidity provisions for foreign banks and encouraging congress to agree a further stimulus package for the unemployed, while also reiterating its ‘low interest rates for longer’ stance.
The fallout from the enforcement of the security law in Hong Kong has continued and tensions between the US and China have again increased. In July we’ve seen visa restrictions on Huawei workers, the closures of consulates and sanctions/visa restrictions for politicians on both sides. And the US has increased its rhetoric calling for an end to blind engagement with China from its western allies. With a November election fast approaching, we expect the nationalist rhetoric to continue, but importantly investors will also be looking to the Democratic Party’s policies to ascertain the strength of this approach if there are changes in the White House.
Markets-wise, US equity markets were the star performers in the developed stock markets in July, delivering strong gains in the face of losses from Europe, the UK and Japanese stock markets. The tech-heavy Nasdaq index leading the way with gains of over 7%, as second quarter earnings have underlined the growth leadership the US big technology companies offer. Emerging markets meanwhile also had a strong month – one of their best for some time, outperforming developed markets by over 4%, helped in part by a weaker US dollar. But with both US equity markets and emerging market equities being priced in US dollars, the returns for Sterling-based investors were much lower due to a weaker dollar. The pound gaining 5.7% against the US dollar in the month of July, meaning much of the strong equity market performance overseas was wiped out for unhedged UK investors.
Government bonds have been buoyed by the continued stance of policy makers to do whatever it takes to keep interest rates anchored towards zero in the near term. Rising Covid infections in the US, but also in many other regions haven’t fractured confidence yet, but it’s clear that we will continue to experience isolated lockdowns as the recovery continues. In fact, we think periodic regional lockdowns will increasingly be a feature of the next 12 months – unless of course a successful vaccine can be found.
Another major mover on the month has been the gold price. With inflation expectations moving back towards their pre-lockdown levels, and government bonds offering negative real (after inflation) yields, the opportunity cost of holding gold has decreased.
At the end of July, companies started reporting their Q2 earnings, with a lot of focus on how big tech has performed – why are technology and growth stocks performing better than traditional businesses? And are they the main driver for stock market recovery we’ve seen since the lows in March?
We’re currently in the middle of earnings season for the second quarter of the year, which means companies are reporting how they performed in the period from the start of April to the end of June.
This period in particular has taken on significant importance this year for two reasons. First, it’s the first time that investors will get real world visibility of the true impacts of Covid on individual companies, particularly in the US. If you think back to the beginning of this crisis, it was really well into March before the US took action to lockdown its economy and so the first quarter earnings only reflected a small part of the impact.
Second, investors have been waiting with bated breath to hear companies’ perspectives on everything that has taken place, and outlooks for the remainder of the year – particularly from those companies considered economic bellwethers, to try and gain a deeper understanding to what’s going on in the global economy.
As far as the results go, we’ve had just over half of S&P 500 companies report earnings. On an absolute basis and as expected, they have been pretty poor, with average sales growth in the region of -12% and earnings growth in the region of -10%. But that’s significantly better than investors on the whole believed it would be, which is certainly a positive when taken alongside some of the positive activity data we’ve received recently from a macroeconomic perspective.
Meanwhile in Europe, we’ve had around two thirds of the EURO STOXX 50 companies report their earnings. Here the story is much bleaker with averages of -27% sales growth and -27% earnings growth. Here we see a much tougher corporate earnings picture in European equities, which really reflects the extent to which the northern European industrial nations are struggling in a muted global trade environment.
Technology stocks are indeed the bright spot. In fact, we’ve seen a very strong set of earnings from the major US based mega cap technology companies, that really stands at odds to what is happening to companies in other sectors.
We’d already had a strong set of results from the likes of Microsoft and Tesla, and last week it was the turn of Apple, Amazon, Facebook and Google. All four exceeded expectations – among the highlights Apple having its second best quarter ever for MacBook sales, overall revenues up 11%, Amazon saw its fastest ever growth in unit sales up 57%, and despite incurring $4bn of additional costs in the second quarter, revenue was up 40% overall. Meanwhile, Facebook delivered 11% revenue growth despite an advertising boycott and advertising revenues globally falling, while Google surprised analysts with its resilience, revenues down only 2% in the face of a very challenging environment.
Why are technology companies performing so well? The first thing to say is this isn’t a Covid thing. Mega cap technology stocks, in particular the famous FAANG stocks, have been dominant for quite some time. They have increased their relative size in the US stock market and have been the growth engine of that market in terms of EPS growth for some time. The five largest stocks – FB, AMZN, AAPL, MSFT, and GOOGL – now account for 22% of the SPX.
At its heart this is really reflective of business models that offer ongoing growth leadership and innovative and expanding product sets, increasing dominance in market share, and increasing recurring revenues. But in this environment, investors have viewed them as the least cash challenged, potentially least disrupted by shutdowns, and best positioned for sustained growth. So, despite valuations of these companies being high relative to their history, they have continued to deliver strong growth and that growth that investors are willing to pay for in the current market environment.
There is some positive news for the economic outlook – what shape do you think the recovery will take?
Alongside company earnings, we’ve seen some positive signs in the macroeconomic data in recent weeks – with manufacturing activity turning up across the world, alongside a bounce in some of the consumer data such as retail sales.
If you look at the financial market recovery, then you’d be hard pressed to call it anything other than V-shaped at the current time. But it’s still too early to predict the recovery in the real economy because much of it is dependent on the path of the medical issues.
We are seeing some positive signs and we can make educated guesses as to the trajectory, but we are still in the eye of the storm to some extent. We only have one or two-months’ worth of hard economic data so far whilst high frequency data such as economic activity continues to analyse market sentiment.
One of the key questions is whether we yet have the confidence that the reopening of economies can be managed effectively. The evidence from Hong Kong, Spain, and Germany is that it’s difficult but achievable. We’re beginning to see that in the UK now too.
What we can say for certain is that policy makers across the globe are committed to driving a robust economic recovery, to do ‘whatever it takes’, to use the words of the US federal reserve. And the IMF global growth forecasts for example, alongside the OBR forecasts for the UK show ‘V shaped’ bounces in growth next year. But we don’t believe it’s a linear path, because the crisis is still evolving and there will no doubt be bumps in the road.
Another thing we can say for sure is that the recovery will be uneven. It will require structural change in some industries, the reskilling of workers, possibly even a re-think about how and where we work. How quickly labour markets adjust to the new normal will be important. It’s easy to forget that Covid isn’t the only dynamic at play in the global economy. It’s clear Covid is here to stay, and that we’ll face disruption of some form, for months or years to come, at least until we have effective control measures such as a vaccine.
There are other dynamics still at play in markets – the US-China trade war that began in 2018, Brexit yet to be resolved, a US election in November. So, it’s really important to take a holistic view rather than focus just solely on Covid.
How did the Nutmeg fully managed portfolios perform during July?
As is often the case in months where we see a lot of dispersion between the returns of different assets, the diversified nature of our portfolios means that returns are somewhere in the middle. For July it’s been a relatively muted month for performance – lower risk portfolios showed gains of around 0.3% and higher risk fully managed portfolios delivered returns of around 0.4%, with medium risk portfolios delivering the strongest returns of around 0.6%.
In this environment, have you made any changes to the Nutmeg fully managed portfolios?
We did make some small changes during the month of July to manage risk in the portfolios. This included rebalancing our equity exposure to ensure we remained aligned with our investment view. As equity markets drifted higher, we have taken the opportunity to trim our overall equity exposure, ensuring we remain slightly underweight what would be our typical long-term position.
We also rebalanced some of our European equity positions. That included trimming our exposure to the Nordics region – which has outperformed the wider European equity market by around 15% so far this year – and also increasing our exposure to a socially responsible European equity strategy, a theme that we continue to believe will perform strongly in the long term.
This month’s customer question comes from Ben, who has asked “Given Nutmeg offers a fully managed socially responsible portfolio range, why do you still offer the standard fully managed portfolios?”
Our socially responsible portfolios are for those investors who want to seek greater alignment between their personal values and their investments. They offer investors the opportunity to exclude companies engaged in controversial activities from their portfolios, while overweighting companies that lead their industry peers when it comes to alignment with environmental, social and governance factors. This means a much lower carbon intensity and a much greater alignment to ESG values.
The goal of these portfolios is to offer this approach with no trade-offs against the core investment principles we believe are key to long term investing success – principles such as global diversification, low costs, transparency and liquidity.
But we also recognise that this style of investing is a personal choice. While the concepts behind this approach are not necessarily new, many investors are only now becoming familiar with this approach and not every type of investment asset is available in this form as yet. So, to some extent it comes down to personal choice, and while we are committed to offering choice, we also want to provide greater education on socially responsible investment to empower our customers decision making over which investment style to choose.
We strongly believe that ESG should be a consideration when investing, and we’re working hard to incorporate ESG considerations in our wider investment process. We currently hold around 18% of our equity exposure across fully managed portfolios in ESG focused strategies, which is partly a reflection of our belief in the ESG methodology and partly a preference to lower carbon intensity of our portfolios in the medium term. Not every type of asset class is available in ESG form as yet, but as product development evolves it’s likely we’ll see many more asset classes become available for socially responsible portfolios and its therefore very likely you’ll see many more ESG focused approaches to assets in our wider portfolios too.
In the meantime, if this is a topic that interests you please do read our white paper – available on the website – or listen to our recent webcast on the topic which is available via our YouTube channel. And as always there’s also lots of great SRI content on our blog, – Nutmegonomics.
About this update: This update was filmed on 4 August 2020 and covers figures for the full month of July 2020 unless otherwise stated.
Data sources: Bloomberg and Macrobond.
Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance.