Exhausted at Halftime

Charlie Parker
Charlie Parker
10-07-2020

We are only halfway through 2020. Let me say that again, halfway through. We have seen life change in ways that seemed unimaginable as we raised a toast on New Year’s Eve.

For investors they have been on a rollercoaster ride as the Coronavirus crisis brought the sharpest and most frightening drops in stockmarkest seen in our lifetime. Whilst standing in a state of shock we watched as the market shrugged its metaphorical shoulders and begun a huge rally throughout the second quarter of the year.

At the halfway mark, and with all the thousands of words written by ourselves and others it is perhaps time to focus on some very simple facts about the markets of 2020.

The recovery from the lows has in our view been driven by two simple points. Firstly, enormous support from central banks and governments. Secondly, the fact that the Coronavirus itself went into retreat in the advanced world. Until we have a working vaccine we believe those two factors will remain all important.

There can be little doubt that the past few weeks have cast into doubt whether the second point can be sustained. This is because whilst here in the UK and across Europe we have kept the virus at bay, in the US – which re-opened whilst cases were still rising – there has been a precipitous surge in virus cases. This lifts the overall rate of infections in the advanced world back up sharply, even as Latin America continues to see the largest surge.

These increases have been felt most profoundly in the South and West of the US. Most importantly from an economic point of view in Texas, Arizona, Florida and California.

Data from State of Florida and State of Texas

We see this as significant, slowing the economic recovery. It has also led to a rapid decline in the polls for US President Donald Trump and led to Democratic challenger Joe Biden becoming the overwhelming favourite. Whilst a Biden victory would undoubtedly bring calm to trade talks it would also prove a likely headwind to sectors such as technology and healthcare. Overall, we believe it would see corporate tax rises amounting to an earnings hit for US companies equivalent to a movement in the Dow Jones of around 400 points.

Now it is worth noting, as the Trump administration does constantly, that whilst US cases are rising the number of people dying is not. This fall in the death rate could be due in part to improving treatment. It seems that simple measures such as turning patients onto their fronts lowers mortality. Likewise, innovations like the Remdesevir drug and steroid medications seem to be making a difference. This will enable the economy to sustain itself in the face of relatively higher level of virus in the population as it reduces the load placed upon healthcare.

Nonetheless, whilst the virus continues to worsen in the US, we believe that despite improving economic data markets will struggle to make significant progress in the short to medium-term. With this in mind we are leaning into defensive areas of the market such as quality and growth.

Over the long-term, we believe the crisis has created a situation where governments must tackle debt by finding new and innovative ways to reduce the cost of money further. This could include negative interest rates and will very likely ultimately include the widespread purchasing of equity ETFs by the Federal Reserve. This process will be accompanied by a desire to create growth and inflate debt away through a surge in infrastructure spending. Whilst more austere solutions may appeal to some, we do not believe governments have the political capital in the advanced world to tighten fiscally from here. This ultimately is due to the declining labour share of growth that advanced economy electorates have seen over the past 20 years.

This trend of falling interest rates and increased fiscal loosening sets the scene for a strong decade for investors in risky assets. In particular it supports long-duration assets within bonds and those stocks which mimic the behaviour of long-duration bonds – namely quality and growth.