Stock market and economic commentary – October 2020

“Headlines, in a way, are what mislead you because bad news is a headline and gradual improvement is not.” Bill Gates, co-founder of Microsoft Foundation.

Is it too bold to assert that we are reaching peak uncertainty? Possibly, although the impending conclusion of the US Presidential elections, ongoing Brexit negotiations, as well as lockdown restrictions and virus vaccine developments do make one think about the world beyond. It is clear that the global economy will be heavily damaged by the policy decisions undertaken to control the coronavirus pandemic but it is equally clear that governments and central banks will continue to do whatever it takes to try to fix it.

The market backdrop remains complex. We are at a critical point of the Covid-19 pandemic and its impact. Coronavirus cases have risen again, particularly in Europe, with further lockdown measures being reintroduced in several geographies, including the UK. This casts a shadow on the economic outlook, particularly for those consumer service sectors such as retail, hospitality and travel that have been at the frontline of the crisis since March.

It is clear that the economic, social and human cost of the measures that have had to be adopted in order to stop the spread of the virus have been devastating and that both policy makers and the public have been completely unprepared for the impact of a pandemic like Covid-19. As with other public health crises, particularly HIV, for which there still is no vaccine, the answer is in a combination of diagnostics, therapeutics, and vaccines. We have made great progress on all fronts and it is notable how many of the companies in which our fund managers invest, operating not just in healthcare and life sciences, but also in other industries, are directly involved in the fight against the disease.

Most importantly for the global economy and for markets is the development of a vaccine. Some informed reports suggest we are only months away from having the first mRNA vaccines from Pfizer/BioNTech and Moderna and that we should be able to achieve a return to normality in the second half of next year. The current second wave will benefit from better diagnostics and therapies that should further reduce the incidence, severity, and mortality of the disease. By the second half of next year the initial vaccines should be joined by other more traditional ones that may engender greater public confidence and therefore have broader acceptance.

But for now, we will need to suffer through the second wave. The difficult decisions to go back into lockdown in many countries will cause great concern. However, governments and central banks have made it clear that they will provide the support necessary to keep our economies going, through any fiscal and monetary means necessary. It is inconceivable that governments in the US, China, the UK and the rest of Europe would risk public unrest, given the political and economic uncertainty and that will be as true before the US elections and Brexit as afterwards.

In a matter of days, the US elections will be over. We all follow the polls but the polarisation and acrimony of the political discourse mean that it is impossible to predict how people will vote compared to what they say before; or how the pandemic and increase in votes by mail will impact the outcome of the elections. It is hoped that all sides will be responsible, that the US electoral system will be up to the challenge, that there is a decisive outcome and that it will be accepted by the winners and the losers. The US economy and markets have done well under both Republican and Democratic administrations and we see no reason to be worried about either outcome.

What is cause for concern, however, is the potential for risk and volatility if the outcome is not clear or if one of the parties contests it. There could be legal battles, as in 2000 but there is also the prospect of violence and bloodshed. There is also the possibility that an outgoing US President and Senate could use the time between the elections and the inauguration of the new President and Congress, to take actions that could have adverse impacts on global political and economic stability. These are real risks, but we have confidence in the US institutions and hope that all sides will see the enormity of this risk and act accordingly.

With respect to Brexit and more specifically a no-deal Brexit, aside from any philosophical and political arguments, many see this is an act of economic self-harm in the middle of an economic downturn of historic proportions. The UK stock market is not however the UK economy and perversely a hard Brexit would possibly benefit equity prices overall. This reflects the high proportion of profits coming from overseas which would be more valuable if Sterling were to devalue following a hard Brexit.

In stark contrast to the political ructions elsewhere, Japan has stood out in recent weeks not just because it was one of the few equity markets that has registered a positive return but because it did so at a time of political change. The transition from Shinzo Abe to Yoshihide Suga, formerly his chief cabinet secretary, was refreshingly seamless by comparison to Brexit and the US elections. Suga has promised to re-energise the third arrow of Abenomics, structural reforms. This may not quite be shock and awe for investors, but the effects could be meaningful. The rock-solid balance sheets and high cash balances in Japanese companies have meant that they are ideally placed to ride out the events of this year. Compare this with the dividend cuts and capital raising seen closer to home.

Markets are caught in a two-way battle between positive and negative influences. On the positive front, global monetary and fiscal stimulus remains extremely accommodative, Covid vaccine programmes are progressing and several segments of the global economy and stock markets are quite well insulated from current conditions: digital, healthcare, and fast-moving consumer goods companies in particular.

At Clarion, our aim always, is to insulate investors as best we can from a wide range of future outcomes and whatever these outcomes may bring. Possible developments over the next few months and years include a big second Covid wave, a speedy mobilisation of vaccines and resolution to the crisis, prolonged recessionary conditions, a strong recovery, deflation, inflation, a difficult or smooth Brexit and not least, the real possibility of negative interest rates.

Insulation from these unknowns can never, of course, be perfect but we try to tread a fine line between capturing opportunities for growth and keeping the portfolios protected in distorted markets. Our aim is to ensure that the Clarion Portfolio Funds retain several key qualities, and we are positive about the following features:

A collection of market leading funds and fund managers with attractive long-term growth potential from investing in companies with healthy levels of cash generation and strong balance sheets.
A bedrock of repeat purchase business models which produce a high level of free cash flow.
For those companies most affected by the crisis, strong competitive and financial positions that should help them emerge in good shape.
Good diversification by geography, sector, and product category.

These characteristics take nothing away from the challenges that the world currently faces, but we do think they should be kept at the forefront of the mind of long-term, patient investors.

In previous commentaries we have discussed several themes that have emerged or accelerated as a result of the coronavirus crisis and are also likely to outlast it, namely:

A greater focus on hygiene and healthcare.
Accelerating digitalisation.
Financial, operational and supply chain resilience.
Sustainability and multi-stakeholder capitalism.

A fifth interesting theme to have emerged over recent months is the shift to a more permanent pattern of remote working and the potential longer-term legacy this will leave on the global economy. The message seems to be that the office is by no means “dead” but an element of home working will continue and the main purpose of the office space will increasingly shift towards employee collaboration, culture building and training. As one chief executive put it, “people used to go to the office to work, and leave the office for team building: now people will go to the office to team build and do their work at home”. This change comes with some complexities. Whilst an element of home working can be incorporated successfully for many job roles, it will not be desirable for every company or individual. The extent of home working will need to be managed carefully.

The flexible working example illustrates a broader point. The best companies have a habit of consistently adapting to whatever is thrown at them over the years as economic, cultural, and epidemiological trends continue to morph and evolve. The recent crisis has thrown much at the companies within the Clarion Portfolios and no one knows quite what the next few months and years will bring. We are however reassured with how many companies have coped and we feel positive about the aggregate portfolio’s ability to adapt, invest, and grow over the coming years.

Given recent headlines, it is not surprising that stock markets have entered somewhat of a holding pattern. Through these trials and tribulations, the Clarion Portfolios have stood the test and our positions in global leading funds that have quality and value have been resilient. However, it might also be surprising, and also equally satisfying, that at the time of writing this commentary, the Clarion Portfolio funds have regained most if not all of the losses experienced in the dark days of March and April and are now flirting with the all-time highs reached earlier this year.

As always, we wish all our clients, families, and friends a safe passage through the difficult months that lie ahead, and we look forward to sharing a brighter future.

Thank you for your continued support and we hope you enjoy reading our regular updates. In future our commentaries and the Clarion e-newsletter will be published at the beginning of each month so the next edition covering November will be issued early December.

Keith W Thompson

Clarion Group Chairman

September 2020

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