Investment Comment May 2020
1st May 2020
Markets have recovered in part from the declines across asset classes seen in March. Aided by stimulus packages from central banks, developed market stocks and bonds broadly rallied. Commodity price indices were less strong, contained by weak global demand and a notable decline in the price of oil. Equity prices reflected improving trends in the pandemic rather than the historically weak jobs, retail and growth data. Meanwhile the VIX, a measure of market volatility, ended April well above its 5-year average, but had calmed notably from the peak reading in mid-March.
April heralded the headline figure of negative oil prices. With supply cuts agreed by OPEC, Russia, and the USA yet to take effect, a large negative demand shock, and a lack of physical storage facilities, West Texas Intermediate (WTI) oil due for delivery in the US in the month of May closed on Monday 20 April at -$37.63. Though the figure made global front pages, it should be noted that this was a temporary and geographically specific event limited to physical deliveries of oil. By contrast, Brent Crude, a benchmark based on North Sea oil, did not experience the negative prices seen in WTI contracts. Even so, as global storage remained scarce, the wider oil market ended April trending sharply downwards.
Declines in oil prices are traditionally seen as beneficial for consumers and companies for whom oil is a major input, such as airlines and transport companies. With severely constrained travel and consumer demand, it is unclear if the impact of recent price weakness will follow historic trends. In the short term, lower oil prices are likely to lead to downward pressure on inflation. However, given the global expansion of the monetary base in response to the pandemic, the medium to long-term outlook for inflation is more difficult to judge.
US equities continued the rally that began in late March, rising 16.63% on the month. This was despite dire readings from many key data points, the most concerning of which was perhaps the jobless claims figure of 30 million since the crisis began. Combined with the extreme volatility in the oil market, the macroeconomic situation does not seem to be reflected in financial markets. When one factors in the sheer scale of central bank interventions, however, the rally becomes more comprehensible. Consensus estimates indicate the Federal Reserve will purchase 20% of the U.S. Aggregate Bond index, a $15trn index often seen as a proxy for US investment grade bonds, in a six-month period. While evidently providing support to the credit markets, this action should also aid equity prices as liquidity on this scale provides cash to weather the downturn and prevents financing costs from spiralling higher.
Equity markets in Europe rallied +7.98% in April as daily cases and deaths from Covid-19 started to trend downwards. Equity markets were also buoyed by several European countries, including France, Germany, and Spain, outlining plans to re-open their economies and relax lockdown restrictions. However, the EU preliminary Q1 GDP reading of -3.5%, the worst since records began in 1995, curtailed market optimism at the end of the month. On the fiscal policy front, the situation was more familiar; European leaders struggled to reach agreement on the terms of a recovery fund, and whether to issue joint ‘coronabonds’. In the 2010-12 sovereign debt crisis, fiscally conservative nations such as Germany and the Netherlands resisted the mutualisation of European debt on the grounds of being unable to control fiscal expenditure in the more challenged EU nations. Thus far, the coronavirus has not brought a deviation from this policy stance which is perhaps unsurprising considering Fitch’s downgrading of Italian debt to one notch above junk at month end.
UK markets rallied less strongly than US markets, up 7.52%, as the oil price decline weighed on FTSE index giants, Royal Dutch Shell and BP. The FTSE’s high exposure to financials also dampened the recovery. Shell’s dividend cancellation in April, its first since the Second World War, came as a shock to the institutional and retail investors who invest in the UK for income. Again, economic data proved historically weak, with retail sales data for March down -5.8% year on year. The commencement of the nationwide lockdown and closure of most shops began on 23 March, so the data does not yet reveal the full extent of the retail sector damage. Boris Johnson announced on the last day of the month that the government would soon publish its plan to ease lockdown restrictions, but stresses that they remain concerned about a potential second wave of infections.
The rebound in Japan in April was less pronounced than other developed markets, with the MSCI Japan index climbing 6.89%. It is worth noting though that, unlike many other developed nations, Japan never entered bear market territory in March. Despite official numbers suggesting Japan’s virus infection rate is relatively low, the Bank of Japan still maintained that the virus was “having a grave effect on the (our) economy” and cut its growth prediction for the current fiscal year to a range of -3% to -5%. In addition, Governor Kuroda seemed resigned to the likelihood of deflation in the short term but stressed long term inflation expectations were not as affected by the crisis. Unsurprisingly, the announcements were accompanied by an extension of the Bank’s quantitative easing plan and a notable increase in equity market ETF purchases.
The world is watching China closely as a leading indicator of the depth of the economic damage and how quickly lockdown measures should be eased. Chinese GDP contracted by 6.8% year on year for the first quarter of the year, which is the first time in 40 years the economy has experienced a contraction. The IMF revised their 2020 forecast for China’s GDP growth from 6% to 1.2%. PMIs published for the month showed recovering confidence from record lows in February, providing some rare positive news.
The MSCI Emerging Markets index returned 10.27% in April. So far, most countries in the sector have been spared the scale of the outbreak seen in Europe and the US, but the rate of increase in cases in Brazil, Russia, and, India may suggest that the spread has merely been delayed. Prior to the crisis, analysts broadly viewed emerging markets to be in a better place than previous crises with inflation under control in most nations and lower levels of foreign debt relative to local debt. The concern is now that with historically high outflows seen in both equity and bond markets since the start of the crisis and rising foreign debt servicing costs as the dollar appreciates, we may see a new wave of defaults in developing nations. To combat this, the G20, the Paris Club, and international consortium of creditor nations, agreed to suspend debt service payments for the poorest nations.
Market sentiment has been boosted by the speed, scope, and coordinated nature of central bank stimuli and plans to ease lockdown measures in some of the worst hit countries. The danger is however that this is a ‘false dawn’ for markets, like those seen in many prior market crises, and not the start of a ‘V shaped recovery’. April has therefore been a textbook example of how difficult it is to time the market and why we believe it is important to take a long-term approach to portfolio management.
This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice as at the date above, 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.