The return of lockdown, equity market volatility and a Hollywood script of a US presidential election. Our director of investment strategy, Brad Holland, takes us through what happened last month from an investor perspective and gives us the outlook for domestic and global markets going forward.
Financial markets seemed to be nervous again in October. That’s two straight months of weakness for equities. Can you give us some colour on that?
Following on from a strong rebound through the third quarter, especially in tech stocks, which had that record August, we did see a downturn in both the US and the UK. The background to this – of course – is that this was coming off an incredibly strong rebound from the March Covid low. But as valuations returned to pre-Covid levels, markets began to ponder a number of variables.
First, the spectre of new lockdowns that has now come to pass. Second, the evolution of policy stimulus to help economies through the Covid pandemic – pre–election posturing meant that further US fiscal stimulus has been delayed. Third, a vaccine for Covid – though this continues to be developed at a rapid pace we won’t see a global rollout in time for winter. And, finally of course, the US election.
So, all these variables have accounted for blunting what was some very notable equity rises through the summer.
For November though, we’ve already seen strong equity markets rallies; partly as a correction from the October drop; partly as the US election result proved to be less disruptive to company earnings and bond markets. More broadly though, the message from US and Chinese economic data has been solid, so there is good reason for some optimism.
This week’s US election was a widely anticipated market event. Did it play out as expected?
Before election day, markets were expecting one of two results: a very clear win for Democrats (the so called “blue wave”) or a very close race and a divided Congress.
A stronger Democrat showing in pre-election polls led markets to anticipate the blue wave, bringing significant stimulus and a reset on the handling of Covid-19. As a result, equities rallied and bonds weakened. But the only poll that really matters is the election itself, and the outcome is close and a divided Congress looks set to continue. Postal votes are still being processed with Republican lawsuits aimed at minimising their impact. Concerns over Covid-19 have led to much higher postal voting in this election, with the widely held view that these are tilted in the Democrats’ favour – which is why Trump is fighting so hard in the courts.
So, what does it all mean?
The election shows the degree of division in the US. A likely split Congress means limited policy progress, at least until the mid-term elections in two years. Not great news for the passionate ideologue on either side, but perhaps comforting for the moderates.
As to what a split Congress means for future US policy:
- Senate control matters: A narrow Republican Senate majority is unlikely to pass tax increases or large fiscal stimulus packages.
- A Democratic Senate would rubber stamp a larger package proposed by a Democratic Congress or a Biden White House.
- Tech set to benefit from division: The regulatory risks faced by the tech sector are reduced in a divided congress.
So, the US election is one uncertainty (almost) out of the way. What are we expecting the markets to focus on next?
In the US – as well as the rest of the world – the policy response to Covid will continue to dominate market thinking. Second wave infections across the northern hemisphere will require ongoing support and we feel that is likely to be forthcoming. We have seen that in recent days in the UK, with the extension of furlough support. The obvious good news on the Covid front is that despite high infection rates there is lower mortality as medics have learned how to treat it and vaccines could begin partial roll out in the UK by Christmas.
Of course, there is Brexit. We are within weeks of knowing if a deal can be clinched between the UK and EU. The mood music is positive but hard-ball politics can still scupper an agreement. We continue to believe a deal will be done.
China and US tensions will likely come to the fore again once the US election is called. There are clear issues around geopolitics and security at stake, but we anticipate that the US and China will learn how to accommodate each other.
China has a self-interest in staying engaged with the West even if that means losing its supply-chain status. The US also has a self-interest in helping China develop its local economy, even if the cost is accepting China’s large and growing political importance in the Asian region. US banks, bond and equity investors are all still welcome in China, which needs their expertise to help ensure efficient allocation of capital. China recognises that its own capital markets need to change if it is to succeed in boosting domestic demand.
Against this backdrop how did the Nutmeg fully managed portfolios perform during the month?
So, the higher risk portfolios were down just over 3% in October. Mid risk portfolios were down around 2%. We are definitely in the middle of a bumpy patch at the moment, which is to be expected from time to time in investing. As I’ve mentioned, we are positive about the outlook, and November is off to a positive start.
Given everything that’s happened lately, have you made any changes to the Nutmeg fully managed portfolios?
Yes, in the light of better news on the Brexit front, we neutralised a long-standing underweight to pound-sterling. We continue to be underweight UK equities, however. We also reduced the size of our US Treasury position, as they have become just as overvalued as UK Gilts.
Our customer question this month comes via YouTube from Chris Carr, who asks: “Would you consider increasing exposure to China given its economic recovery and Europe’s/USA’s weak recovery and the fact that more lockdowns are coming?”
Good question Chris! I’ve already spoken a bit about our thinking on the US and China. For both, the Covid issue is a real one, but we think policy measures will continue to be supportive on that front. Meanwhile, we are impressed with both the US and China’s economic data. It’s less easy to access China equities directly, but global indices are gradually incorporating more China large cap stocks. The emerging market ETFs we hold in the fully managed portfolios track these indices. Though, at present, we have a fairly neutral holding.
Our fully managed portfolios are constantly under review and, if we think the emerging market space deserves a greater weight, we will certainly move in that direction.
About this update: This update was filmed on 5 November 2020 and covers figures for the full month of October 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 performance and forecasts are not reliable indicators of future performance.