Investment Outlook

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April 08, 2020

Investment Outlook

Tom Elliott

Market sentiment: Much improved. Investors are looking beyond what will be terrible economic data over the coming months, to a global recovery in the second half of 2020. 

Large government emergency spending packages, together with central banks announcing bond purchase schemes and easing fears of a shortage of dollars, helped stop the decline in global stock markets a fortnight ago. The subsequent recovery has endured, and the longer it does so the less suspicious investors will be that it is a so-called ‘dead cat bounce’. A steady return to normal life in China, and this week an apparent peaking of COVID-19 deaths in Italy and Spain, have further lifted sentiment, as has hope of an agreement between Saudi Arabia and Russia to curb the oversupply of oil. 

The return of risk. Investors are eagerly looking for and buying, under-priced and distressed assets. Highlighting this was the huge demand last week for a new $3bn bond from Carnival Corp, the cruise operator, that is part of a $6bn fundraising effort by the company to avert possible bankruptcy should the COVID-19 pandemic persist. The bond came with a coupon approaching 12%, with its boats offered as collateral, and it attracted $17bn of subscription. The company’s shares are up 41% since a low of 2nd April, following the success of the bond issue and the purchase of a slice of the company by a Middle Eastern investor. 

The slothful FTSE100. The U.S and Japanese stock markets have led the global rally. In contrast, the U.K's main market index has been a notable underperformer. The FTSE has been hit by weak commodity prices affecting energy and mining companies, and bank dividend cuts. 

Market outlook. We know that the economic data over the next few months will be dreadful. Double-digit drops in GDP growth is expected to be reported for the second quarter in most OECD countries, along with extremely sharp increases in unemployment. There will be a severe hit to corporate earnings, with dividend payouts and share buy-back schemes curtailed as companies retain cash in their balance sheets. 

But stock markets are looking beyond this. The coming weeks look set to see a decline in COVID-19 deaths in Europe and the U.S, and governments will then start to unwind the lockdown measures. Given the extent of government support to the major economies, in the form of state-backed loans to businesses, furloughed wages, and ultra-low interest rates, it is reasonable to expect that many of the jobs lost or put on temporary hold in recent weeks will be quickly re-opened. If so, consumer and business spending might return to pre-crisis levels quite quickly during the third quarter of 2020. Indeed, pent-up demand could stimulate a mini-boom in many sectors, such as consumer durables (ie, autos, household appliances, etc). 

A broadly based, multi-asset portfolio should help investors through any further volatility until capital markets are back to normal.

Oil. Brent crude is up $10 a barrel from the $23 low that it fell to on the 30th March. President Trump erred last week when he Tweeted that Russia and Saudi Arabia had agreed to take out approximately 10 million barrels per day (mbpd) to prop up oil prices. There is, as yet, no agreement. However, talks between the three countries are -apparently- in progress, and there is speculation that Saudi Arabia and Russia may make significant cuts in output in response to the approximately 25 mbpd estimated drop in global demand (from 100 mbpd consumption, before the pandemic crisis). 

Trump has repeatedly vowed not to ask U.S oil producers to cut production, and indeed getting the agreement of the hundreds of oil companies -and overriding domestic anti-trust legislation- would be a Herculean task. But Russia’s attempt to strangle the highly-indebted and comparatively high cost, U.S oil shale sector through forcing down prices is putting pressure on the oil sector as a whole. Last week it was reported that Whiting Petroleum, a big independent producer, would file for Chapter 11 after failing to repay £262 million on an outstanding convertible bond. Trump has already switched from being a cheerleader of cheap oil (because it benefits the U.S motorist) to a supporter of higher prices. Will he go further and declare his support for an oil producer cartel, to help rescue a major industry in many Republican-voting states? 

Thanks to shale oil, the U.S is now the world’s largest oil producers, at 13 mbpd, Saudi Arabia follows at 12 mbpd, then Russia with 11 mbpd. 

U.K. Prime Minister Boris Johnson remains in intensive care but thankfully does not have pneumonia. While his poor health has alarmed the country in recent days, there is no reason to believe it should impact on sterling or U.K financial assets. There is widespread consensus within the parliamentary Conservative Party surrounding the key policies of the government, and any interim leader can be expected to follow them.. These can broadly be described as follows: follow expert advice over managing the COVID-19 pandemic, a trade agreement with the E.U, investment in the Midlands and the North of England, and funding for R&D into new technology. And – like many other governments around the world- to avoid alienating President Trump or President Xi, by being seen as over-compliant with the other’s wishes. 

Furthermore, the British civil service has the capability, and certainly the self-confidence, to continue to run public services without a government for a prolonged period of time. Anyone familiar with the T.V show ‘Yes, Prime Minister’ will be familiar with the idea that many senior civil servants, across the world, find politicians a hindrance to the smooth running of their departments. This attitude is profoundly anti-democratic, but does help ensure functioning public services during periods when no government can be formed (ie, Belgium), or indisposed due to illness.

Sterling is, however vulnerable and will remain volatile. Recent multi-decade lows for sterling against the U.S dollar partly reflect dollar strength, as investors have flocked to the greenback as a safe-haven currency. However, the pound has its own problems which will outlive the COVID-19 crisis. First is the no-deal option that the U.K government continues to maintain as a policy in its trade talks with the E.U. Second is the large current account deficit that the U.K runs. This, in the words of former Bank of England's head Mark Carney, makes the U.K dependent ‘on the kindness of strangers’ to provide investment, loans and the purchase of financial assets in order to balance the books. The current account deficit is equivalent to 4.3% of GDP, making it the largest of any major economy. The good news is that a weak currency will support growth.

Swiss franc. In stark contrast is Switzerland. Foreigners have sought out Swiss franc-denominated assets as a safe-haven asset class, putting upward pressure on the currency that has deflationary ramifications on the domestic economy. Exports become more expensive for foreigners and imports cheaper so weakening domestic producers. The un-wanted kindness of strangers contributed to the franc reaching a four year of CHF 1.05 against the euro, and an all-time high of CHF1.12 against sterling, three weeks ago when market stress was at a peak. As a result of the inflows of capital the country boasts a current account surplus equivalent to 9.9% of GDP, the largest outside of Asia, and even more distorting for the domestic economy than the U.K’s deficit. The Swiss National Bank has set a deeply discouraging interest rate of -0.75% to discourage foreign holdings of francs and has repeatedly been selling the franc on foreign currency markets to bring down its value. 

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