“A real man smiles when in trouble, gathers strength from distress and grows by reflection.” Thomas Paine, political activist
August is a time for reading and reflection. This year has turned out to be very different from what we expected. So much of our everyday reality has changed because of Covid-19. It has been a great challenge to adapt in our personal and professional lives which has brought concern, adversity, and distress to many. Covid-19 has reminded us all that health, wealth and freedom are not a natural state of being and can be snatched away in an instant.
However, it is also striking how resilient our societies and economies have been in the face of the unprecedented measures taken to contain the spread of the virus and how quickly and effectively global science and technology has been able to progress towards diagnosis, treatment and protection.
Covid-19 continues to cause social and economic disruption around the world. Second waves are breaking out across Europe. The number of confirmed cases hit a new daily high with almost 300,000 declared worldwide, bringing the total to more than 24 million. Total deaths from the disease are now over 800,000. Thankfully, despite often misleading headlines, both daily death and infection rates are now falling. The USA remains by far the worst affected country, followed by a slew of emerging market countries such as Brazil, India, Russia, South Africa, Mexico, Peru and Chile. The days of China as the epicenter of the virus are long over, with 28 countries having surpassed its total declared cases. Europe has followed the Asia Pacific economies in restricting the virus to isolated outbreaks, typically occurring in densely packed cities or warehouses. Until a vaccine is discovered, rolling localised lockdowns will be the ongoing reality in developed economies.
The second quarter has borne the full impact of measures taken to contain the pandemic on economies and companies. Economies have contracted at record rates, dividends are being scrapped, government deficits are soaring out of control and unemployment is about to hit record levels in every developed economy. And yet stock markets remain resilient and some, notably the US, are within touching distance of the highs reached earlier in the year.
Unsurprisingly this has once again led to a discussion as to whether there is a disconnect between the stock market and the real economy. Are investors becoming completely unhinged and irrationally exuberant? Or is it a case of the authorities creating another asset bubble by unleashing a flood of liquidity into financial markets.
It might look that way, but the historical records show that of the 13 post war recessions, stock markets have risen during nine of them and often by more than they have in this downturn. In truth, markets are doing just what they always do; when the economy turns down, stock markets head up and sometimes dramatically so.
By their very nature markets are forward looking. Investors buy into the future; the past is past and no longer of concern. Every recession is followed eventually by an upturn. The business cycle is exactly what it says it is. A cycle: things turn.
Indeed, it could be argued that markets have been rational throughout this period drawing a clear distinction between the best and the worst companies. The Covid-19 pandemic has accelerated many of the changes and disruptions of the past ten years, none more so than the shift from offline to online in most areas of economic and social activity. Some companies have prospered while others have faltered. The shares of companies with pristine balance sheets are close to all-time highs, those with weak balance sheets remain in the doldrums.
The winning stocks are the ones which have benefited from lockdown; the digital economy leaders and the predictable or subscription business models such as Amazon, Peloton and Ocado all of which are held by our fund managers. With a focus on quality and value for the long-term our fund managers have been able to identify many companies whose businesses have benefited from this acceleration of change because of the strength and resilience of their businesses and balance sheets.
Recent corporate results have shown how disparate the performance of companies can be. Several companies in the key areas of digital and online, smart communications, health care and life sciences, have reported record results. Others in consumer products and industrials have shown resilience in absorbing the impact of lockdowns adjusting their costs and using their balance sheets to take advantage of opportunities and to make acquisitions.
August was also notable for a remarkable slip in the dollar against other currencies. Traditionally, the dollar has been one of the most robust safe havens for governments and investors, especially in market downturns. This coincided with a rush into gold, pushing the price per ounce north of the previous all‐time high in 2011, briefly above $2000. This hints at market expectations that the dollar will remain weak, and low interest rates will be the reality for a long time to come. Conversely, sterling has regained much of its lost ground against the dollar (hitting $1.32) since Boris Johnson reiterated his adamancy that the Brexit transition period would not be extended beyond 2020. The Euro also gained strongly by circa 5% against the dollar.
It is also remarkable that 86% of the global bond market now yields less than 2%, with 60% yielding less than 1% and 25% offering negative returns in exchange for investors capital. 50% of the bond market offered 4% or better in 2005.
It is worth noting that the UK Government is able to borrow money for 30 years at 0.80% per annum.
This environment favours financial asset whose value lies further into the future, such as growth companies with low current earnings but with high growth potential. Stocks and shares in general are also a clear beneficiary of the low interest rate environment. This is rational as long as cash interest rates and bond yields remain low which is highly likely until underlying inflation pressures return. Balancing a portfolio of stocks in both the growth and value camp is also increasingly important in the current environment. Diversification by investment style, by geography, by sector, by asset class is more important than ever.
As pandemic fears ease the risk reward balance between portfolio concentration and portfolio diversification appears poised to rotate favourably towards the latter.
What then can we expect in the second half of the year? Undoubtedly the next few months will also contain a wide range of outcomes for consumers, companies, and investors. Much will depend on the progression of the pandemic. There are signs of increasing infection rates as measures are being lifted. So far these have been modest compared to the infection rates seen earlier this year. Measures like the UK quarantine period imposed on certain countries seem to be motivated more by politics than science. Far more important will be if infection rates increase as the Northern Hemisphere enters the Winter season. We have made significant progress in testing and treatment of the disease, but a significant increase will lead to the re-imposition of measures even if they are unlikely to be as stringent as they were before.
Whatever the future holds it is the businesses that were bold while the competition dithered that will be rewarded by their customers and clients. The pub that adapted and stayed open on July 4th while others stayed dark. The adviser that kept in touch regularly throughout lockdown. The sports that found a way back on to your screen while others wrote off the summer. Reputations are being made and others irreparably broken. Ambition and confidence are qualities to admire in a counterparty.
While the recent flare-ups of the Covid-19 virus in countries which had largely quashed it are concerning, we believe that the considerable increase in testing, particularly in developed economies, is a significant positive. This will allow for more targeted responses against localised outbreaks, which is key to stopping the re-imposition of economically damaging countrywide lockdowns. In this regard, along with the rapid progress of medical research, we remain positive on the global recovery and equity markets and continue to favour equities over bonds.
With the exception of the travel, hospitality and retail sectors, corporate results have been resilient, valuations are attractive, progress in vaccine development is promising and fiscal and monetary support is likely to be ongoing. We believe the companies in our portfolios offer compelling value for the long-term investor and any volatility will be a buying opportunity in precisely the same way as March of this year.
As always, we wish all our clients, families, and friends to stay safe, stay well and to look forward to a brighter future. Thank you for your continued support.
Keith W Thompson
Clarion Group Chairman
Creating better lives now and in the future for our clients, their families and those who are important to them.
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