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Consumption to the rescue… so far

How long will the market rally last?

29 October 2020

Our Chief Investment Officer talks about the recent rally in stock markets and the latest changes in portfolio positioning.

The current landscape

It’s been a busy month for newsflow with politics taking centre stage. Meanwhile, expectations for the delivery of a viable, widely available, approved coronavirus vaccine have slipped back.

Back in May, the Bank of England expected UK GDP or output to be about 20% below its pre-coronavirus level over the course of the third quarter. However, on latest estimation, that deficit appears likely to be closer to 3% or 4%. A similar-sized adjustment has been made by forecasters looking at the world economy, providing useful context for the sharp rally in stock markets over the last couple of quarters. In the UK, much as elsewhere in the world, consumption has proved to be more robust than feared and policymaker action more vigorous.

With regards to Brexit, most seem to agree that the range of plausible outcomes is likely narrow. Recent newsflow would indicate a skinny trade deal is a little more likely than previously throught, though of course much can change. Whatever the outcome, investors would do well to remember that the UK economy is simply not a major player in the world's capital markets. Most of the time, even the UK’s capital markets tend to be more influenced by the evolving outlook for the US economy.

In terms of portfolio positioning, we think that the growth and inflation outlook baked into the long end of the yield curve remains too gloomy, relative to our own expectations of what is likely to materialise. Meanwhile, in the high yield space, the spread over government bonds has come in a long way which has been very good for holders of so-called junk credit such as us. There may be a little more to go for.

As ever, we recommend investors get invested, stay invested and stay diversified.

Consumption to the rescue… so far

As part of our aim to keep clients informed of our current investment views and how these themes are impacting your discretionary portfolios, Phil Attreed, Head of Investment Consulting, talks to Will Hobbs, Chief Investment Officer, about the recent rally in stock markets and the latest changes in portfolio positioning.

Phil: Hello and welcome to this October edition of Monthly Market Insights. I’m Phil Attreed, Barclays Head of Investment Consulting, and as usual I’m joined by Will Hobbs, our Chief Investment Officer, as we look back over the last month's news flow and also look to the month ahead. So Will, September was a month where capital markets across the world took a bit of a pause for breath maybe; the world was reminded that there's a pretty challenging political timetable as we head into the end of the year but also the economic recovery, which we've seen now some way off of its lows from earlier on in the year, does seem to have slowed a little bit. How would you characterise the last month or so from the team's perspective? 

 

Will: Hi Phil. It's been a very busy month I think, that's the first thing to say, again news flow wise. Certainly the politics has been centre stage for much of that time. However, you've also had a slight slip in – just looking at the shorthand for expectations, professional forecasters expectations with regards to delivery of a viable, widely available, approved vaccine. That timetable seems to have slipped a little bit in investors' minds, so you've seen the probability just pare back a little bit with regards to a delivery in the first half of next year. I’m not sure there was too much new in the last month in terms of news flow nonetheless, relative to expectations, none that would change materially change our range of probabilities. But talking about changing expectations, one interesting thing I did see, and you and I have spoken about this before, was the Bank of England were pointing out that back in May their expectation for the UK economy – and remember that professional forecasters at this time were much gloomier than the central bank forecasters in large part – anyway, they were expecting the UK economy over the course of Q3 should be about 20% below its pre-COVID level in terms of output. By the time they get to now, while we're recording or just the week of the recording, the expectations the Bank of England has for the same period, the end of Q3, is about -3% or -4% down on its pre-COVID average. Now you've had, like I say, professional forecasts about an even bigger jump to make but that really does show you how far expectations have moved over the course of the last few months and that also underlines, in my opinion it helps explain at least or provides useful context for that sharp dramatic rally in stock markets that we've seen over the last couple of quarters. It's not founded on hot air. It's founded on changing or changed expectations with regards to the underlying economy. The UK is similar to the rest of the world: consumption has proved to be more robust than feared and policymaker action has been more vigorous.

 

Phil: So just looking back at those political risks for investors they seem to be evolving pretty quickly. We've obviously got Brexit very much front and centre of people's minds from a UK perspective and of course the headlines are full of US election news flow as well. How are the team thinking about both of those two elements, the impact potentially for portfolios, and any related action that you guys might be looking to take? 

 

Will: Yes, with regards to Brexit we fall back on the idea that most of the time the UK economy is just not a major player in the world's capital markets. Even those domiciled in the UK to be honest it tends to be the US economy somewhat perversely that's the major influence most of the time in UK domiciled assets or UK quoted assets. So Brexit, if we look at it, there's a fairly narrow range now of expectations with regards to what happens at the end of the year from a very skinny trade deal to an exit without a deal. The economic consequences of those, it's again quite a narrow range in a sense. So one has to wonder whether it's that important for the world of investments. It's very important for those of us living in the UK but for the world of investments, I’m not sure. It's not going to be the primary story on many senses and there are going to be other factors to consider with regards to US elections. I mean in a way it's a similar story but when you're taking a position on something like this and you're saying, “Okay, well, I want to try and beat the market here, I think the market is underestimating the potential for this particular policy or that particular policy”. In that situation you've got to identify the particular policy to start with, you've also got to identify that the market is underpricing the risk that that policy will be implemented. So you've got to go back and say: okay, well you're going to take a guess at the political hue of Congress; you're also going to take a guess at the occupant of the White House by then; the wedge of probabilities has got so thin that you wonder if there's really any point in making a strong move in the first place. And if you do spot – the opportunities are few and far between in that space. So if we're looking at the US elections in general and people are looking potentially at the aftermath but what you'll see already just to that efficient pricing story is a volatility kink in the options curve. So what you can see is forward pricing. Investors are already assuming that we're going to see sustained volatility after the US elections. So if something is expected it makes it harder to take a different position unless you think that the market is wrong in that expectation but for our sense we don't have a strong enough conviction here to take positions. We focus on the primary drivers of capital markets which most of the time are not the occupant of the White House. 

 

Phil: And I suppose that just leads me on to our usual, regular final piece, the client portfolios and funds that we're running, the client money that we have under management and its positioning. The tactical element of the portfolio is still very slightly tilted particularly in the riskier part of the fixed income, the bond part of portfolios, for slightly better times positioned for slightly better times there. Maybe if you could just share some thoughts from the team around our current asset class positioning. 

 

Will: Yes, sure. I think better times relative to expectations as priced into those assets and so if we look at government bonds in particular. We've thought this for some time, we still think it, we do sense check this view on a regular basis and really put the stress through it. And we still find sufficient support for this view, let's say, which is that the growth and inflation outlook baked into the yield curve long end is just too gloomy relative to our expectations of what will likely or the range of probabilities that will likely materialise. So we're holding on to that underweight position. We own a few less government bonds than we usually do but on the high yield space it's interesting because what you've found is the spread over government bonds has come in a long way that's been very good for holders of junk credit, so-called junk credit. We think there could be still a bit more to squeeze out of it and the thing that's interesting here is that the policy response particularly the Federal Reserve has really changed the roster of risks that you look at with regards to high yield to a certain extent. It's maybe minimised something in that spectrum of risks and so we think that at least it deserves to go back, the spreads deserve to go back to pre-crisis average and so there may be still a little bit more to squeeze out there. So those are the major positions that we have at the moment and like you say, the tilt is slightly to the positive, the belief that a lot of the glass is half empty at the moment for investors. That's not too hard to verify. We look at all sorts of investor sentiment indicators and most of them are pointing to investors viewing the world with some suspicion at the moment which is understandable. We're entering what is likely to be a very challenging winter. But we have to look a little bit beyond that with our tactical allocation and looking beyond that we see reasons to be cautiously optimistic, I would say. 

 

Phil: Thanks Will, really very useful update as we head into the autumn. We'll of course be back next month but for those listeners who want to stay in touch with us in between now and next month's edition please do seek out our regular weekly Word on the Street podcast where you'll be able to find on all of the usual channels, and in particular a little more detail we've recently issued an autumn edition of that as a special as well, which we know has been well received by many of our listeners. Otherwise we look forward to being back with you next month.

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