June was a volatile month for markets. Continuing uncertainty around the economic impact of coronavirus was offset by a strong employment rebound in the US. In the near-term, our investment team continues to keep a close eye on Brexit negotiations and the US presidential election.
After rallying strongly in April and May, financial markets seemed to be quite up and down in June. It seemed they were still being driven by news about coronavirus and concerns over new cases. Is that right?
Yes, and no. Markets were up and down – that would be an understatement. There was an 8% range in the main US equity index in June, with it finally finishing up 2%. The UK’s FTSE 100 was a little less volatile, ending the month up 1.7%. Bond markets also shared in the ‘rollercoaster’ behaviour.
However, the volatility was not primarily about coronavirus. The big initial rally at the start of June followed the hugely impressive 2.5 million employment bounce recorded for US in the month of May. That was a wake-up call for market participants getting overly bearish about the global economy. Asia had already been showing signs of a rebound since it was the first to come out of lockdown.
However, coronavirus did have some impact, with a second round of virus infections being reported, which, for some, places a question mark over the recent positive run on equities. Even after the June US employment figures reported another spectacular 4.8 million increase, the level of US employment remains 14 million (10%) below the February peak.
This explains why there’s still a lot of talk about recession, with some commentators even suggesting the UK will be one of the worst-hit countries. Are you concerned about recession?
We have already been in recession, in the UK and every other main economy. The enforced shutdown was like turning the lights out on major parts of the economy. The UK is no different to any other countries in this respect. Certainly, the UK policy response in order to get the UK economy back on track has been very impressive, so there is no need to think of the UK as a weak link in that respect.
There is a widely reported view that COVID infections are worse in the UK compared to other affected countries, and that this would restrict UK economic growth. But these statistics are not directly comparable from one country to the next. Certainly, until we have better data on how widespread COVID really is across global populations, there is no reason to think the UK should perform any worse than other major economies in the economic recovery phase.
Where, of course, the UK can be singled out, is on its trading relationships. The final form of its trading relationship with the EU from 2021 is still up for grabs. And a reasonable expectation would be that UK activity would be adversely affected by a no-deal scenario.
So, is there anything investors can do about recession risk? And aside from the coronavirus, are there any other big events influencing financial markets at the moment?
You rightly ask if there is anything investors can do about recession risk. Well yes. They can pay very close attention to what policy makers are doing. So far, they have adopted a ‘whatever it takes’ attitude towards minimising the long-term economic damage of the shutdown. That means stimulus. If things take a turn for the worse? Expect more stimulus. And this seems to be what the market has come to realise. First, that any future virus lockdowns will be more localised than what we have seen so far this year – so less disruptive; and second, that policy makers are on the case. And who pays for all this stimulus? Well of course we all do in the long term, but that is not a major consideration in the near term.
And that brings me to the second part of the question. What other ‘near-term events’ we should focus on. The US election could bring a significant change in style of US policy – particularly in China relations. A major question if the Democrats win the White House is whether they would seek to unwind the corporate tax cuts implemented by President Trump. That would be a negative for equities. However, given the reliance on companies to re-hire so many unemployed workers, the Democrats may decide to go softly on corporate America. And how will a potential new administration change the current US-China trade negotiation dynamics?
While on the topic of trade, I can’t finish without mentioning Brexit. What will the UK’s trade relationship look like next year? The end of July seems an important deadline for the UK government to get it sorted. October seems more important for the EU. Either way, expect a lot of news will flow over the next month or two. And Nutmeg retains a cautious stance in its fully managed portfolios.
How did the Nutmeg fully managed portfolios perform during the month?
Fully managed portfolios rose between 1% in lower risk portfolios up to just under 3% in higher risk portfolios. With the strong equity market performance in the second quarter, half of our fully managed portfolios now have flat or positive returns for the year to date.
In this environment, have you made any changes to the Nutmeg fully managed portfolios?
Yes. We trimmed some of our US equity overweight into Japanese equities and we swapped some European equity exposure into a socially responsible European equivalent. We also swapped some US corporate bonds to higher yielding US bonds.
This month’s customer question came from a reader named Patrick on our Nutmegonomics blog. He asked, “I noticed that over half of my Nutmeg pension pot is invested in the US. I appreciate that the S&P 500 has performed really well recently thanks largely to growth from big tech firms, but doesn’t the lack of geographical diversity leave us exposed in the event of another tech crash?”
The US exposure of our portfolios will vary depending on the investment style and the level of risk that you have chosen. Broadly speaking in higher risk portfolios US exposure will come mainly via US equities and some US fixed income.
Socially responsible investments, which I believe is where Patrick is invested, will have higher US allocation because the socially responsible space is not yet as fully developed as regular index investing. So, in these portfolios more fixed income exposure is currently US based rather than UK based. The higher risk SRI portfolios have between 34% and 46% US equity exposure, along with US fixed income exposure between 10 and 20%. So, exposure is not equities alone. That’s why you’ll see over 50% in the US. Still though, this compares to the regular MSCI World index where the US is over 60% weight.
Turning to the point on technology companies, we do not place a high probability on a tech crash and see this sector as forging the new ‘automated and connected’ economy. While valuations in the tech sector have attracted attention, return on equity remains high, and with recurring revenues increasing and strong balance sheets we still maintain the tech-heavy US bias for now. For our fully managed and socially responsible portfolios, we are managing the US equity position carefully and should our risk assessment change we will adapt.
About this update: This update was filmed on 7 July 2020 and covers figures for the full month of June 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.