New Fed Policy Pushes Markets Higher
US equity markets reached all-time highs for a third day running this week, with investors welcoming Federal Reserve Chair Jerome Powell’s new approach to accommodative monetary policy. The S&P 500 and the Nasdaq Composite stock indices notched fresh highs, meanwhile Treasury yields increased, and the dollar weakened. At the same time, signs of a recovery in the US economic fundamentals waned, leading us to take profits on US exposure following strong performance.
Federal Reserve policy is set to remain supportive of the US recovery as Jerome Powell indicated ac shift in inflation targeting policy today at the Jackson Hole symposium – an exclusive annual affair for central bankers, senior policy makers and highly regarded economists. Within the meeting, officials discuss new ideas and address solutions to the challenges they have faced since the last meeting. Taking place on the 27th and 28th of this month, interesting news and developments are already making the headlines.
For more information on The Jackson Hole Symposium and changes to Fed policy, please see the attached Market Update Document
Another Market Record
After a rapid initial recovery, recent labour market figures suggest that the US recovery may be waning, while business investment and consumer spending remain low. This suggests that the continued challenge to contain the Coronavirus outbreak across the US has caused the recovery to lose some momentum, with uncertainty weighing heavily on the economy. Against this backdrop it is hard to make a case for US markets to move significantly higher, though they seem to be being propped up by stimulus and a lack of alternatives for investment managers. As such, the recent outperformance of mega cap stocks has raised concerns over a potential rotation from growth to value moving forward, with growth stocks now trading at extremely high valuations. The forward-looking price-to-earnings ratio for the S&P is now at the highest level since the tech boom seen in 2000, raising our concerns that at worst this is a bubble, or at best the index may be due a pullback.
One insightful paper appears to have identified a potential cause for the observed disparity between US mega-cap tech firms and the rest. Two economists, one from the Fed and the other from the University of Chicago, have suggested a decline in knowledge diffusion has reduced the ability of laggard firms to learn from frontier firms, which in turn reduces the laggard firms productivity and their potential ability to compete.
This research has come amidst a time when there is growing political pressure on firms like Alphabet and Facebook to be broken up, alongside the growing anti-trust movement against the technology sector. The authors believe the pandemic may worsen the outlook for productivity growth in the future if it allows big companies to take advantage of their smaller rivals, leading to even less competition. As a result, this paper may begin a discussion amongst policy makers to address the widening disparity in a bid to ensure more Americans win from economic growth.
Virus Cases in Europe rise
Europe is facing a resurgence in coronavirus cases, however authorities are showing almost no willingness to reimpose strict lockdown measures like the ones we saw in March and April. The uptick in cases in recent weeks has been blamed on social gatherings and travellers. Instead of re-imposing lockdown restrictions, the bloc is seeking to battle the public health crisis without delivering another blow to economies. German Chancellor Angela Merkel urged European leaders to work together to avoid reviving lockdowns, calling instead for unified action. Containment measures focus on targeted initiatives, such as clamping down on nightclubs, requiring masks to be worn in public areas and mandating people returning from hard-hit regions or prove they’re not carrying the disease. Overall, we expect to see cases re-emerging while a vaccine remains unavailable, however the key will be to keep cases at manageable levels across the bloc.
Brexit Deadlock
Pessimism has returned to Brexit talks as once again negotiations are at a stalemate. UK officials submitted a revised draft Free Trade Agreement based on where they believe there is common ground with the EU, though the efforts are yet to lead to a breakthrough. The UK document which hasn’t been made public is a consolidated text that enables negotiators to narrow down the list of discussion topics to areas where differences remain. The move is also designed to force the hand of the EU, which has been reluctant to take such a step because of its demand for “parallelism.” Rather than agreeing on the least contentious topics first and moving on, the bloc insists on discussing all subjects at once -something UK officials say has paralysed the process.
The two sides are still far apart on access to British fishing waters and the so-called level playing field requirements aimed at preventing a distortion of competition. The final round of talks are scheduled to end on October 2nd, which is considered to be the final deadline if any deal is to be implemented in time of the end of the post-Brexit transition period on the final day of the year.
Positioning
Following the conclusion of our quarterly Investment Committee Meeting this week, we have taken advantage of the extreme valuations in US markets this week to reduce our US equity exposure as the S&P 500 hit another all-time high. The move allows us to lock in some significant profits at a time when we see limited upside remaining in US mega caps while risks increase as the recovery wanes in some states. It also allows us to redeploy the capital into more attractive areas of the market on a Value at Risk basis. In its place, we are looking to add more thematic exposure to areas such as multi-cap tech stocks and wider areas of the US market which are set to benefit from the societal shifts that are occurring as a result of the coronavirus pandemic.
At the same time, after strong performance in recent months we have also taken this opportunity to reduce our exposure to government bonds, as yields are at very low values compared to historic averages (prices of bonds move inversely to yields) and are likely to only increase from here as the outlook continues to brighten and risks abate. Moving forward, we will be increasing our exposure to investment grade and high-yield corporate debt, areas which we see continuing to benefit as risks reduce. This shift will allow portfolios to benefit from improving trading conditions for corporates as lockdowns ease, and profits return.
Key Events We Are Watching This Week:
- Friday: EU Economic Sentiment, BoE Governor Andrew Bailey Speech
- Tuesday: US PMIs for August, EU Inflation and Unemployment
For anyone who wants further data to substantiate the position please review the attached Global Economic Update document and the Economic Dataset below.
Model Portfolios & Indices
Global stock markets continued to display high levels of volatility over the week as countries across the world battle with virus challenges, mixed economic data, and stimulus expectations. Over the week, the major indices experienced mixed performance on rising virus cases and mixed economic data which varied significantly between regions. The portfolios remained relatively robust in the face of market volatility over the week, benefitting from a high level of diversification in asset classes and geographies.
Looking ahead, we are optimistic on the medium-term outlook from here, accepting further volatility in the near term, but confident in our positioning, with well diversified portfolios which have been designed to weather these market conditions. Year to date, we have now recovered from the March coronavirus decline, and we are in a strong position moving forward.
Important Information
Past performance cannot be used as a guide to future performance and the value of your investment will fall as well as rise in value. You may not get back all of your investment and the final value of your investment will depend on the performance of your portfolio. The actual performance of an individual client’s portfolio may differ due to different funds being used and being restricted in relation to certain asset allocations. Performance figures quoted include fund manager charges but exclude adviser, discretionary, custodian and switch charges. Unless stated, income is reinvested into the portfolio. The information contained in in this document is for information purposes only. It does not constitute advice or a recommendation or an offer or solicitation for investment.
This Day in History
In this day in 2008, Democratic politician Barack Obama became the first African American to be nominated for the presidency by either major party; he later defeated Republican John McCain to win the office.
Have a great week,
Jason & Gina
