Almost four years after the European Referendum and nearly 50 years after first joining, the UK has now left the European Union. Brexit is finally done although we are still in a period of transition until the end of 2020 and for now at least most of us will hardly notice any difference. While not quite magnanimous in victory nor gracious in defeat, Brexiteers and Remainers alike appear to be moving on, and more importantly, moving forwards. Whatever side of the Brexit or political debate you sit on, the present situation should give Britain a momentum we have not seen since 2016.
Of course, we still need to sign a free trade deal with Europe but if that is achieved, and once we have a new, hopefully strong, leader of the Opposition, we will return to a world of strong political debate, respected rule of law, and exciting prospects for the UK. Various economic surveys and hard data are already inflecting upwards in the UK, and around the world, masked of course by the recent panic over the coronavirus. In time this strength should shine through, which when coupled with the inevitable fiscal stimulus, could create a positive tailwind for stock markets.
However, whilst we have left the European Union, uncertainty about where we are heading and what our place in the world will be remains high. In uncertain situations pessimism reigns, yet optimism triumphs as many times as not. We at Clarion err on the side of positivity, or at least a more neutral stance compared to the worries seen from others. In support of this view, it is worth noting that at the turn of the year we saw meaningful green shoots signaling a pickup in the global economy.
Within equity markets, investors who had begun to rotate portfolios out of growth and into value stocks last October sharply reversed that trend, and the largest stocks with the highest growth potential regained their leadership position. In the early part of the month, stock markets around the world continued to hit or approach new highs. This was despite news headlines being consistently negative. In the face of sluggish economic growth, Middle East tensions and the impeachment saga, the 11-year bull market in stocks & shares continued to sail on regardless.
This, however, came to a shuddering halt in the final few days of the month as a “Black Swan Event”, in the shape of the coronavirus hit the headlines. Initially centred around the Wuhan region in eastern China, the disease began spreading to other parts of the world and the number of confirmed cases, and deaths, escalated.
In reaction to the economic dangers posed by this scary global menace, government bond yields fell dramatically, safe havens such as gold rose and stock markets fell sharply as concerns surrounding the knock-on effect to global growth and corporate profits weighed on investors risk sentiment. In the short-term stock markets are likely to be driven by news headlines and developments associated with the outbreak. The hit to economic data is very likely to get worse before it gets better.
However, the sharp declines in stock markets in the final few days of the month should be considered in the context of a very strong start to the year with several stock markets, led by the USA, hitting record highs in the early part of February. Even as markets were hitting new highs, bond yields were heading lower suggesting that investors were seeking the safety of government bonds whilst at the same time embracing risk with stocks and shares. This is puzzling but scraping beneath the surface there is less contradiction than you would think. Comparing the performance of the various stock market indices, investors have a pronounced preference for big, apparently safe, growth-focused shares. In other words, this is still a very cautious bull market, one that lacks depth or conviction. This could indicate there is still plenty of fuel in the tank for a recovery and further uptick in stock markets once the coronavirus threat dissipates.
The virus poses a major threat to all countries and there is a concerted global effort to deal with the issue and mitigate the effects. To some extent demand and supply shocks can be offset by policy stimulus of the type we have already seen in China where the authorities have been active in keeping the availability and cost of credit flowing and competitive.
Fiscal stimulus in other regions is also becoming more and more likely. For example, the authorities in Hong Kong have just announced that every permanent resident over 18 will receive HKD 10,000 (about £1000). Whilst this is a relatively small amount and is due to political unrest as well as the coronavirus, it is an important reflection of how policy is shifting. It is highly likely that other regions will follow with similar policy action.
Episodes such as this can be disconcerting for even the most experienced investor, but the best approach is to sit tight and do nothing. Anything else is an exercise in our old but unreliable friend, market timing. Every serious investor who has decided that the stock market will form the cornerstone of their financial future will, if they sell now, want to buy back at some stage. The question then becomes “When?” and will prices be higher or lower. Nobody knows.
The best approach is quite simply to Hold on. Legendary Investor Warren Buffett has said the fall should be regarded as a buying opportunity. The real question, he says, is: “Has the 5,10 or 20-year outlook for top quality businesses in America and the rest of the world changed in the last few weeks? Definitely not!”.
With these points in mind our strategy remains broadly unchanged. We are comfortable with our positioning and are not seeking to make any major changes to our portfolios. We maintain our preference, subject to our risk parameters, for equities over bonds and cash. In fixed interest we retain a short-dated tilt which we believe provides a good trade-off between yield and interest rate risk. In equities we maintain our overweight positions to the UK, Asia and Emerging Markets as we feel these are areas with the most growth potential and best relative value. Whilst recognising the US is home to some of the largest, most exciting growth companies in the world, we are concerned about valuation levels and maintain our underweight stance for the time being. We are also neutral on Europe because of the increased and, for now, uncertain political risk.
We will of course continue to monitor developments relating to the coronavirus closely.
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