Market Commentary Update - October 2020

Here is a summary of investment markets for the month of October 2020

Global share markets weaker

Global share markets fell in October, driven largely by fears that governments may be forced to impose harsher (and potentially economically-destructive) coronavirus containment measures as the spread of infections globally continued to accelerate throughout the period. Spain, France, Germany and the UK were amongst those countries to implement additional restrictions, while several US states, including Wisconsin, reintroduced lockdown measures after the number of new cases there threatened to overwhelm hospitals. Compounding this was news that several vaccine trials, including those by Johnson & Johnson and Eli Lilly & Co., had suffered various setbacks. Stocks were also impacted by the US government’s continued failure to agree a new economic stimulus package, the prospect of a contested US presidential election and the European Central Bank (ECB)’s decision to maintain its current, albeit ultra-easy, monetary policy rather than introduce further stimulus. In saying that, ECB officials did at least hint that the Bank could introduce additional stimulus at its next meeting in December. Sentiment was further impacted by ongoing Brexit uncertainty and some cautionary comments from US Federal Reserve chairman, Jerome Powell, who reiterated that the outlook for the US economy remains highly uncertain and inextricably tied to the ability of the government to contain the spread of coronavirus. Other factors to weigh on share markets were a series of disappointing European economic data, including weaker euro-zone jobs and industrial production figures, news UK unemployment hit its highest level in more than three years in August and a late sell off in US technology stocks.

Limiting the decline was a strong rebound in US growth; the world’s biggest economy expanding at a 33.1% annualised pace in the third quarter. The outcome marked the country’s largest-ever expansion and followed the 31.4% contraction we saw in the second quarter. We also saw further encouraging growth in China, with gross domestic product there coming in at 4.9% year-on-year in the September quarter. Whilst the outcome was less than the 5.2% growth the market had anticipated, it was still faster than the 3.2% annualised growth recorded in the second quarter and confirmed that the country’s post-coronavirus recovery is continuing. Stocks also benefited from further fiscal stimulus in the UK and an uptick in US corporate activity, including Advanced Micro Devices’ USD35 billion bid for Xilinx. Sentiment was further buoyed by a series of encouraging US third-quarter earnings updates, with the likes of JP Morgan, Citigroup and General Electric all beating analysts’ expectations. However, there were some notable misses on the US earnings front, including Intel, Boeing and Bank of America. We also saw better-than-expected earnings results from several European names, including UBS, Airbus and Philips.

At the country level, stocks fell in Europe, the UK, the US and Japan but rose in China.

Looking ahead

Markets are in the early recovery phase of the business cycle following the recession caused by the coronavirus outbreak. This implies an extended period of low-inflation, low-interest-rate growth, which is an environment that usually favours equities over bonds. However, after such a rapid rebound, an equity market pullback would not be surprising. Technology stock valuations remain elevated, while the US election is creating uncertainty around tax changes, government regulation and the US-China trade relationship. Beyond this, we believe the market looks set for a rotation away from technology/growth leadership toward cyclical/value stocks. This also implies a rotation toward non-US stocks which, in our opinion, would likely benefit Europe and emerging markets the most.

We maintain our preference for non-US stocks over US stocks. The second stage of the post-coronavirus recovery should favour undervalued cyclical value names over expensive technology and growth stocks. Additionally, we believe emerging markets should benefit from China’s early exit from lockdown and further stimulus measures.

For fixed income assets, we continue to see government bonds as universally expensive. Low inflation and dovish central banks should limit rises in bond yields during the recovery phase. In terms of credit, we have a neutral view on high-yield and investment-grade debt. Since their levels in mid-March, credit spreads have compressed and, in our view, only now adequately compensate for the likely rise in default rates following the recession.

In the currency space, we expect the US dollar to weaken into the global economic recovery due to its counter-cyclical behaviour, which has historically seen it decline in the recovery phase. Economically sensitive ‘commodity currencies’ like the Australian, New Zealand and Canadian dollars should be the main beneficiaries of this.

Moving forward, the major risks to our outlook include a second wave of virus infections and the US elections in November. Virus infection rates are picking up and the onset of winter in the northern hemisphere could trigger a more significant second wave. However, death rates have remained low in most countries and vaccine developments have been encouraging. The US election result may be contested, with destabilising implications for financial markets. We believe the re-election of President Donald Trump would likely benefit US stocks (tax hikes averted, more protectionism) whilst a victory for Joe Biden may benefit non-US stocks (more harmonious foreign and trade relations).