The significant stock market rebound seen in the second quarter continued into the third quarter. US stocks led the way and finished the quarter strongly, up 8.4%. Indeed, at one point in early September, the S&P500 index was higher than it was pre-COVID. Stocks in the Far East and emerging markets also rose, aided somewhat by the continued weakness of the US dollar. European stocks lagged their US counterparts and the UK, the FTSE 100 was again held back owing to its heavy weighting in banks and oil – which continued to struggle against lower interest rates and falling energy demand.
Throughout the summer months, market sentiment was understandably most influenced by the evolving data on COVID-19. In both the US and Europe, it was difficult for investors and company boards to make long term decisions in such a fast-changing situation, particularly as company dividends, a key metric in valuing share prices, were being curtailed or cut altogether.
However, what was clear was that the central banks of the US, UK and eurozone remained resolute in their determination to provide stimulus in the form of lower interest rates and other stimulative measures. The Federal Reserve cut interest rates to a range of 0%-0.25% and the Bank of England may well have followed suit had it not felt the need to keep something in reserve in the event of a no-deal Brexit. The US 10-year bond yield fell to 0.7%, having started the year at 1.9%.
In addition to this accommodative action, the Federal Reserve also pledged to hold rates at this level for as long as it takes for inflation to pick up to 2%. With the Fed’s balance sheet now having doubled to WW2 levels of debt, one might have thought that the resulting flood of cheap dollar would cause inflation to spike quickly. However, we have been here before in the wake of the Great Financial Crisis in 2008, and the market took the view that low interest rates are here to stay.
The summer months were a little soon for economic data releases to back up the general optimism seen in the stock markets, although it was clear that in the US at least, there had already been a dramatic and encouraging bounce-back for jobs in the leisure and hospitality sectors. This will be an important factor in the November US Presidential election. In April, unemployment spiked to nearly 15% – a long way from the February figure of 3.5%, a 50-year low. The US recession has been the deepest for a hundred years, but it has also been the shortest. By November, the economic data could be much more encouraging.
The UK and the eurozone also find themselves similarly distracted from COVID-19 by Brexit. Perhaps unsurprisingly, negotiations that should’ve been wrapped up by the end of June, were kicked into October with both sides reluctant to give up on key issues. This has taken the edge off Sterling and the general view is that the resulting weakness has given international investors sufficient justification to sit it out on the side-lines with a wait-and-see approach to investing in the UK.
However, disappointing the global progress on fighting COVID-19 may be, our knowledge of how it works and impacts our lives is at least better understood than it was. Treatment has undoubtedly improved. Failing some unexpectedly dire new twist in the evolution of the virus, one may be afforded greater confidence in long-term investment opportunities. That is not to say that COVID-19 will not influence markets, but they may be less inclined to follow every twist and turn in the data; it’s possible that government policy error poses a greater threat to the economy than the virus itself.
We may also face the distraction of no-deal Brexit or an indecisive US election result – both of which would make for volatile markets. Our objective in managing the client portfolios remains one of limiting downside in volatile and unpredictable markets, as we have done in numerous previous cycles. However, we re-iterate our that the long-term balance of risk does appear be, in our view, turning more positive.