Monthly Market Review
Review of markets over the third quarter of 2020
The third quarter emphasised the benefits of geographic diversification. Asian equities returned over 10% and are the joint best-performing equity region year to date, up over 5%. Meanwhile, UK equities fell 3% and are down 20% year to date. European equities also lagged the rest of the world, with returns of 2% and -7% for the quarter and year to date respectively. US equities delivered nearly 9% over the quarter and over 5% this year.
Asia’s strong performance has been helped by China’s remarkable success in containing the virus. This has allowed subway usage in China’s major cities to recover to only 10% below 2019 levels, compared with tube use in London, which remained down more than 60% even before the latest work-from-home measures were announced.
In the US, the summer started with a sharp rise in the number of people in hospital with Covid-19, but since late July that number has declined sharply, perhaps helped by increased use of face masks. In Europe and the UK, hospitalisations have been very low for most of the summer, but have started to creep up, with Spain and then France and the UK seeing a rise in cases. This has prompted concerns that, as summer turns to autumn and temperatures drop, hospitalisations and deaths could start to rise more meaningfully.
Exhibit 1: Asset class and style returns
On a more positive note, vaccine trials have been progressing, with the Oxford trial recommencing quickly after a brief pause. Clearly, positive news on this front in the coming months could be a game changer for markets, potentially leading to a significant rally in some of the stocks that have lagged this year.
US growth stocks, which have benefited from the shift online caused by Covid-19 this year, came under some pressure in early September, having had a good quarter until then. With valuations still high by historical standards, a vaccine-driven rotation could potentially lead growth stocks to underperform cheaper stocks. On the other hand, value stocks remain particularly exposed to the worst-case scenario of a bad winter without positive vaccine news.
The US election is also heating up, with polls now suggesting that Trump has gained ground in some key swing states, such as Florida and North Carolina, but still needs to make further gains in at least two of the other key swing states of Arizona, Michigan, Pennsylvania and Wisconsin if he is to retain the presidency. In the race for the senate, polls currently imply either a Democrat majority or a 50:50 split. If the senate is tied, the vice president would get the deciding vote. The Republicans’ best chance of retaining a Senate majority is to win the seat for North Carolina, whereas the Democrats could win an outright majority in the Senate by winning in Iowa or Montana (see US election microsite).
The race for the White House and control of the Senate has gained even more importance than usual in light of the pandemic and the recent inability of the Democrat-controlled House and Republican Senate to agree on further fiscal stimulus to support those who have lost their jobs. Whether the US passes further fiscal stimulus post-election could be important for the economy and markets in the coming months.
Exhibit 2: World stock market returns
In the UK, fiscal stimulus is also fading. The newly announced job support scheme is less generous than the furlough scheme. The end of the furlough scheme at the end of October is therefore likely to lead to a rise in unemployment. While the number of people on furlough has declined from about 30% of all jobs at the peak, around 10% of jobs remained on furlough at the start of September. In Europe, in contrast, support measures for workers affected by Covid-19 have been extended.
On the monetary policy front, the big news over the quarter was the Federal Reserve’s shift to average inflation targeting, allowing inflation to run above target for a while to compensate for periods of below-target inflation. The key implication is that rates are likely to remain lower for even longer. US 10-year Treasuries ended the quarter with a yield of 0.7%, broadly flat over the quarter but down from 1.9% at the start of the year.
Exhibit 3: Fixed income sector returns
There was a meaningful move lower in sterling in September (down 3% against the dollar). A lack of progress in the Brexit negotiations is the most likely explanation. Discussions have been complicated by the UK government’s placing of the Internal Market Bill before parliament. This bill seeks to modify the terms of trade between the UK and Northern Ireland that had been enshrined in the EU withdrawal agreement.
We still think the most likely scenario is a limited free trade agreement with considerable transition arrangements to ease the ‘day one’ burden of change. However, the risk of a more adverse scenario is rising (see Brexit OTMOI).
The prospect of no deal is also influencing expectations of Bank of England policy. The Bank is currently reluctant to fully endorse a shift to negative interest rates, but market pricing suggests negative interest rates will be introduced at some point in 2021. Ten-year Gilt yields ended the quarter at 0.25%, up slightly over the quarter but down from 0.8% at the start of the year.
The final quarter of the year could be particularly eventful. By January, we should know the outcome of the US election, whether a no-deal Brexit was avoided and whether US Congress has passed more fiscal stimulus. Most importantly, there is a good chance that we will get news on a vaccine. For now, we continue to believe the focus should be on diversification, both regionally and by asset class, with alternative and targeted absolute return strategies playing an increasingly important role in portfolio diversification. However, we also think it’s worth considering what to buy if we get good news on a vaccine.1
Exhibit 4: Fixed income government bond returns
Exhibit 5: Index returns for September 2020 (%)