Understanding the marketsUnderstanding the markets

Investment Comment December 2020

November was an eventful month for capital markets. Joseph Biden won the US Presidential election, and there were breakthrough trial results of Covid-19 vaccinations from Pfizer/BioNTech and Moderna, which both recorded over 90% effectiveness. Equity markets rallied globally, with the MSCI World up 9.23%. Previously shunned sectors such as cyclical stocks and emerging markets benefited on hopes of a return to normality in the new year, and several beneficiaries of the pandemic registered large declines. Debt markets also welcomed the news and saw Emerging Market and high yield indices turn positive year-to-date. However, the market appetite for gold, the popular safe-haven play, faded.

US equity markets gained in November as the MSCI US rose 8.00%. High growth stocks rose steadily while out of favour industrials, airlines, and financials rebounded sharply. While there were breakthroughs in vaccination trials, cases of Covid-19 in the US continued to grow sharply. States considered imposing lockdown measures again, as the centre of the pandemic moved from the Eastern Seaboard to central states.

Joseph Biden claimed victory in the US election, edging out Donald Trump in key states such as Georgia, Pennsylvania, and Michigan. Biden’s victory will have long term implications for markets, particularly if Democrats also win the Senate and are consequently able to follow through on their $2.2tn fiscal stimulus plans. Biden has placed sustainable infrastructure at the centre of his economic plan and is expected to re-sign the 2015 Paris Climate Agreement. Moreover, the President-elect is a Europhile with a commitment to international institutions like NATO, the UN, and the WHO. It is unclear whether Biden will continue Trump’s policy of pressure on China or return to the relatively cordial relations of the Obama era, but this key relationship will likely continue to define global trade.

Asia Pacific equities also gained in November, albeit less than US and European markets. The MSCI Asia Pacific ex-Japan index rose 4.63%. India’s economy fell into recession in November, although the scale of the decline was less than expected. Year-on-year GDP declined by 7.5% in Q3, compared to the forecast 8.8% drop. Narendra Modi’s government has been accused of supporting oligarchy interests, firstly in agricultural reform that removes a minimum price paid for farmer’s produce, and in proposals to allow conglomerates access to the previously off-limits banking sector. Despite the toll taken on the economy, India may benefit after the pandemic from a realignment in supply chains. While India’s manufacturing sector is not as developed as in China, closer ties with the US and Europe leaves the country in a position to gain global market share.

In China, the long-anticipated IPO of Ant Financial was prevented by regulators, who took exception to CEO Jack Ma’s statements on Chinese state-owned banks and the regulatory environment. The move had a negative impact on Chinese equities. The Communist Party appears to be reasserting itself over powerful tech companies and their CEOs, after a decade of relatively hands-off treatment. This compounds pressure on the Chinese tech sector from US and Indian sanctions. Meanwhile, several lenders themselves came under duress after a wave of bankruptcies at state-owned enterprises (SOE). It was previously believed regional governments would bail out their local SOEs to protect jobs, but the recent internal debate has led some to conclude that uneconomic SOEs ought not to be supported. Whether this foreshadows a greater reliance on free-market mechanisms, or conversely whether the central government will intervene, remains to be seen, but it appears that investors can no longer rely on local governments backstopping SOE debt.

European markets led the November recovery, and the MSCI Europe ex- UK index gained 13.40%. On the assumption of a return to normality, The European Central Bank indicated that it would embark on a new round of stimulus in December. The news pushed bond yields lower across the continent. Portugal’s 10-year bonds were briefly in negative territory, but just eight years ago the same note had a 16% yield. Having been on the precipice of the European debt crisis in 2012, Portugal’s bond yields reflect both an underlying economic recovery and greater creditworthiness, but also the increased role of the ECB in pan-EU financial stability. However, critics argue that with the ECB’s balance sheet at 53% of Euro-area GDP, monetary expansion is losing its effectiveness, or that in any case, Europe does not need further monetary stimulus.

The UK spent November under a renewed lockdown, while the MSCI UK index soared 13.10%, benefitting from a rotation back into cyclical sectors that dominate the index. However, Chancellor Rishi Sunak warned “the economic emergency has only just begun.” Record borrowing, high forecast unemployment, and increased taxation were likely to dominate the economic agenda in 2021. Britain and the European Union inched closer to a Brexit deal. Even so, key sticking points remain. The European Securities and Markets Authority (ESMA) indicated it would treat EU area banks operating in London under more stringent derivatives rules, rather than UK rules, creating uncertainty over the $50tn derivatives market in London.

Arcadia, the retail group owned by Sir Philip Green, went into administration at the end of November. The company owns brands such as Topshop, Dorothy Perkins, and Burton, and is the highest profile casualty of the pandemic on the high street thus far. Up to 13,000 jobs are at risk, a reflection of the extreme difficulty facing bricks and mortar retailers in the UK. The UK also became the first to approve the Pfizer/BioNTech vaccine, providing hope that the end is in sight, both for retailers and the economy.

The MSCI Japan index rose 8.95% over the month, against a backdrop of rising Covid-19 cases from October. GDP rebounded strongly in the third quarter, up 5%. Japanese exports supported the economy, as business and consumer spending remained well below pre-pandemic levels. Given the level of cases, Japan is likely to return to a ‘state of emergency’ scenario, especially considering the country’s ageing demographics. Prime Minister Yoshihide Suga’s initial popularity has been damaged somewhat by the spike in cases. The new PM must call an election within a year of taking office, which will now likely be pushed back until after the virus is contained.

Hopes for an effective vaccine also spurred a rally in Emerging Market equities, as the MSCI Emerging Markets index rose 5.81%. Net inflows to both equities and bonds have followed months of outflows as investors sought safe havens from the pandemic in developed markets.

Weakness in the US Dollar has boosted EM economies, many of which rely on the greenback for foreign exchange and issue debt in the currency. Foreign investors return to Turkey after Naci Agbal, who replaced President Recep Tayyip Erdogan’s son in law as Central Bank governor in November, signaled his intention to raise interest rates to combat spiraling inflation and currency devaluation. Emerging Markets have perhaps the most to gain from a vaccine.

November provided markets with positive developments, leading to a record monthly rise in global equities. The dollar and US Treasury prices declined, indicating investors were exiting these safe-haven assets and redeploying capital to hard-hit sectors such as cyclical companies and emerging markets. While this is encouraging news, we remain alert to the fact that the Coronavirus pandemic is still with us, and its economic consequences will remain long after vaccination programmes have been rolled out. November has shown that rotations into unloved markets can be swift when the macroeconomic forecast changes. At Cantab we encourage clients to remain diversified across geographies, asset classes, and investing styles for this reason.

Risk Warnings This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice as at 1 January 2021, both of which may be the subject of change in the future. The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice. Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling. Investments in stocks and shares should therefore be viewed as a medium to long-term investment. Past performance is not a guide to the future. It is important to note that in selecting ESG investments, a screening out process has taken place which eliminates many investments potentially providing good financial returns. By reducing the universe of possible investments, the investment performance of ESG portfolios might be less than that potentially produced by selecting from the larger unscreened universe.