Punter Southall Wealth
View from Punter Southall Wealth
“Back to Reality”
Like many of you possibly have or will soon be, I have just returned from a relaxing and rejuvenating holiday (as those of you with small children will know, there are different definitions of the term “relaxing”). I’m sure there will be many of you who decided to stay in the UK this year, as we did, with the Isle of Wight having had the dubious pleasure of welcoming the boisterous band of Beckets (and my somewhat quieter wife). Time away from the house, which has become both one’s living and working space over the last four months, offered the chance for reflection on a tumultuous year so far and the opportunity to reappraise the prospects for the global economy and financial markets.
Whilst it was great to go away, it is always nice to come home. However, this time it felt different to the returns from holidays of the past. Indeed, the feeling that overwhelmed me as I sat down to work at my desk in my home study was one of “here we go again”, and a return to the uncertainty of the last few months. We might well be living in a world where asset prices have made a near full recovery, but the economic and medical situations remain enigmatic and open to a range of different outcomes in the coming months and quarters. Moreover, the chance of further market volatility in the remainder of this year and beyond is very high. It is understandable that we all live in an anxious state about the future.
We now know our economic limits
The economic situation has become clearer in recent weeks. We have seen that the developed economies have reopened to the point where keeping COVID-19 under control is much harder. As one of our contacts put it eloquently on a recent call, “we have reached a plateau of economic growth”, until something materially changes with the medical situation; further removal of restrictions will likely lead to a resurgence in cases of COVID-19. We have therefore seen the limitations enforced on various new-found freedoms, including renewed restrictions on travel, a delay of further re-openings (my three year old boy is furious at the further delay to the opening of bowling alleys, indoor swimming pools and soft-plays) and a smorgasbord of various other explainable (and often unexplainable) policies. Whether one agrees with the broad policy mix of actions or not, it is becoming increasingly clear that the current state of semi-economic paralysis is here to stay until the virus is beaten or a vaccine is developed. This, therefore, remains an open-ended situation that is extremely hard to forecast.
What can we learn from China?
There has been plenty of discussion over whether we can use China as a leading indicator for our own immediate future, given that the authorities in the Middle Kingdom appear to have gained a high degree of control of their own COVID-19 situation. We are now not sure that we can. The nature of the Chinese government and the relatively authoritarian approach that they can take with their population, probably means that they are at a significant advantage when it comes to quelling COVID-19. However, we can learn from their current economic experience. The positives are that the Chinese economy is bouncing back, and various parts of the industrial and manufacturing economies are back up towards full capacity. Furthermore, sales of larger products and activity in the housing market are also relatively healthy. Darker clouds hang over the retail and services sector, with clear evidence that the appetite to go back to shops and restaurants is presently limited, and we have to assume that without a definitive defeat of COVID-19 or the “silver bullet” of a vaccine(s), these parts of the economy will continue to act as an anchor on overall growth. In addition, one can’t just assume that these problem parts won’t infect and affect the rest of the economy; a company or sector can make all the products they want, but if they aren’t subsequently bought, then it will cause overcapacity issues and inefficient growth. China is now back up to around 80-90% of pre-COVID economic activity, according to our specialist contacts. If it stays at around that level, and we take this as a guide for the rest of the world, then that is a very worrying prospect.
Medical developments are key
So, what are the chances that a medical solution is found? We should reiterate that we are not medical experts, but there appears to be building optimism that a vaccine can be developed and that there should be widespread distribution early next year. This is by no means certain, but the people that we have listened to in the medical sector suggest this as a “base case”. There are obviously risks to any forecast around a successful vaccine, and we assume that asset markets will continue to oscillate on news around vaccines and therapeutics. Should a successful vaccine be developed and distributed then economic growth will be on track to achieve the economic levels that we last saw back at the end of 2019, as we have forecast for the end of next year. There remain both upside and downside risks to this or any other economic forecast at this time of high uncertainty.
Bridging the gap/ Papering over the cracks
As you will all know by now, the governments have responded to the enforced closure of their respective economies by trying to limit the economic damage through unprecedented levels of spending. Indeed, as I write, various parts of the US government are trying to hatch the latest fiscal package to follow those versions from early in the crisis that are now starting to expire. As the governments have no money due to persistent over-spending in the past, they have had to rely on the largesse of private sector investors, many of whom have been forced by regulations in the post financial crisis decade to swallow the governments’ growing supply of treasury bonds (apparently to make them safer), along with the central banks of those nations, chief amongst them those in the US, Japan, Europe and the UK. To put in simple context, the growth of the “balance sheets”, or the total assets “owned” by those central banks, has almost perfectly matched the meteoric rise in the trillions of dollars of outstanding debt of various governments over the last six months. These actions from central banks have been understandable given the scale of the crisis that has unfolded, and have prevented the global economy from collapsing, but let’s be honest and recognise that this is a sign of our future, as we have long been forecasting. Going forward, governments will be under pressure to spend extraordinary amounts of money to try to quell social discontent, bridge the ever-widening gap between the “haves” and the “have nots” and avert the “climate crisis”. The central banks will have no choice but to work hand in hand with the governments in a likely vain attempt at righting various injustices and trying to keep the economy moving forward. As you know, this is a key reason why we believe in the virtues of inflation-proofing strategies and gold.
Will the financial alchemy work?
We cannot forecast whether the hyperactive behaviour of governments and central banks will ultimately be a help or a hindrance to the economic potential of the global economy and asset markets in the long run. In the short term, we would suggest that they had to do “something”, given the decisions that our politicians took to shut down their respective economies. However, the actions of the government and central bank partners have been much more supportive of asset market gains, rather than generating economic activity, with a clear, obvious and growing disconnect between investment market levels and cyclical areas of the global economy. In part this reflects the fact that any company with perceived defensive earnings growth streams, such as those in the consumer staples or technology sectors, has been revalued at much higher multiples, but also the simple fact that there is so much “liquidity” sloshing through asset markets looking for a home. This is perfectly reflected in the fact that, at the end of July, we saw record high monthly closes/ record low yields in US equities, US government bonds, US investment grade corporate bonds and gold. Any one of these major asset markets claiming new heights would be noteworthy, but all four at the same time is another truly remarkable fact for the history books. In the longer run, we have deep suspicions that the helping hand of governments and central banks will lead to more extreme outcomes for the global economy and asset markets, particularly around the prospects for rising inflation, which is almost certainly what the near-parabolic move in gold has been telling us over the last few months.
Asset prices brush off economic weaknesses
Given how far “under water” most asset markets were at the end of March 2020, it is somewhat astounding that, as we ended July, most markets had enjoyed a near complete “V” shaped recovery. Obviously, there are some notable exceptions, including the languishing UK equity market, but there is broadly almost no reflection of the economic damage experienced so far this year in the levels of global asset markets. Many of our clients have asked us if this disconnect is sustainable. We have to admit that we simply don’t know, but there appears to be no desire on the part of central bankers and governments to stop the flow of money to investors and markets, with some politicians in the US actually admitting that asset prices are being deliberately propped up. We struggle philosophically with this outright manipulation, but we must recognise that it is taking place. This does not mean that we should throw the long-held investment principles out of the window, but there are occasions when we need to adjust our thinking on specific investments. In addition, when one scratches beneath the surface of headline equity indices, it is immediately visible that there has been an ever-widening bifurcation between those companies and sectors perceived as winners of the COVID-19 crisis and those viewed as losers. Our job is to analyse whether the “losers” have become sufficiently cheap that they offer the necessary prospects for attractive recovery returns and, whilst we remain well spread across geographies and sectors, we are seeking an entry point to once again increase our allocations to those contrarian assets that are universally disliked by investors.
Undoubtedly this year has panned out in a totally different manner to that which we forecast at the start of the year, and we have had to reconsider all our core economic and market views and adjust our clients’ investment portfolios accordingly. At times we have had to ignore the grim economic and medical short-term reality and hold our nerve on assets, which were vulnerable to specific short-term pressures, but that offered long term value. We are pleased to have enjoyed a major recovery, and importantly can still find a number of assets that could provide healthy returns in the coming years. However, there are still plenty of major issues for us to consider as we shape our clients’ investment strategies, not least the unresolved medical crisis, the pervasive economic uncertainty, and the divergent performance of asset markets when compared to the economic reality. It will come as no so surprise to any of you that we continue to believe that a balanced and diversified strategy is the appropriate approach for the months ahead, whilst we will continue to try and exploit the peaks and troughs in investor sentiment, with a number of tactical investment decisions. 2020 has been a frenetic year so far, and we are not labouring under the illusion that the coming weeks and months will not be similarly challenging, but we are confident in the merits of the investments we own for our clients. If the year continues in the same vein as we have experienced so far in 2020, then another holiday might well be needed before too long. Maybe this time I’ll leave the children at home to “relax” by themselves.
We thank you for your ongoing support and hope that you continue to enjoy the summer.
Tom Becket, CIO
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