Quarterly update: Markets emerge from coronavirus crisis
Our quarterly investment update for Q2 2020 finds markets optimistic about the post-coronavirus economy.
3 min read
Investor confidence grew steadily in the second quarter as the trend in infections reversed, and governments and central banks maintained supportive economic policies.
Accordingly, stock markets around the world bounced back from the sudden and sharp falls in Q1 as the initial panic subsided and investors started to consider the opportunities ahead.
Coutts Head of Asset Allocation Lilian Chovin says, “After reducing our exposure in Q1, we’ve brought our equity position back up to neutral (versus benchmark) over the second quarter as markets have bounced back, and we’ve added to our holdings in corporate debt. There might be more volatility over the summer as markets adapt to the new circumstances, but we’re cautiously optimistic for the long-term trend.”
ON the road to recovery
Most markets recorded substantial rises between April and the end of June – the S&P 500 had its best quarter since 1998, and the FTSE 100 its best since 2010. This demonstrates how quickly markets can bounce back after big falls, and adds context to our consistent message that long-term investing often requires riding out bumps along the way.
The stock market rally was initially led by the health care and tech sectors, which proved relatively resilient during the worst of the sell-off. In May, some sectors that had struggled earlier in the year saw positive returns, including banks, energy and oil, transport and homebuilders. This pattern suggests investors are now more confident about the prospects for the broader economy and are looking for value in sectors that have been hit hardest.
Despite improving investor sentiment, stock markets are yet to fully recover from losses earlier this year. UK stocks, in particular, have fallen behind other markets – the FTSE 100 includes a high proportion of energy and oil companies, which have suffered due to falling demand during lockdown, and a lower proportion of the tech and health care stocks that benefited most from the outbreak.
Investing for better times ahead
Lilian highlights changes in allocations over the quarter in reaction to the evolving investment backdrop. "Overall, we’re looking at economically sensitive sectors and areas that will benefit from an economic upturn as lockdown measures are lifted.”
We’ve increased our holdings in Japan, which has the potential to recover well as its prime export markets in Asia reopen their economies.
We also introduced US banks as an investment theme, in the belief they offer value as America continues to show signs of economic recovery. In the UK, we’ve moved away from a focus on domestic-oriented companies to invest in a broader range of quality companies with sustainable business models.
Credit markets rebound
Investment grade corporate bonds rallied as investors regained their appetite for risk. Government bond yields rose (and prices fell) over the three-month period. However, since the start of the year, they have delivered a positive return owing largely to the flight-to-safety that took place in February and March.
In April we reduced our allocation to US Treasuries to take profits and used the proceeds to add to our UK gilt holdings. In addition, we sold some of our emerging market bonds and added to our investment grade credit positions. The economic fallout from the coronavirus pandemic weakens the investment case for emerging market debt, while the prospects for high-quality corporate debt are more positive.
Lilian observes, “Central bank stimulus measures have helped to reduce risk levels for corporate debt, particularly of large companies with strong balance sheets. With base interest rates likely to remain at historic lows for some time, corporate bonds are more attractive than government bonds and can also provide diversification benefits.”
Recession, not depression
Business activity in many countries fell to the lowest levels on record. The IHS Markit Purchasing Managers’ Index (PMI) dropped to 13.8 in the UK, and 20 in the US, in April. Any number below 50 indicates that activity is expected to fall, but since the recent lows PMIs have shown signs of recovery – in China, where lockdown restrictions have largely eased, PMI was 54.5 in May.
Crucially, we don’t believe this downturn will extend to a depression. Lilian says, “Unlike the financial crisis in 2009, this isn’t a systemic crisis. The pre-coronavirus economy was in good shape, and the recovery is building on a sound financial foundation.”
Markets are largely ignoring the bad news and focusing on central bank and government stimulus measures. In the UK, the Bank of England extended its bond-buying programme and indicated that record low, 0.1% interest rates will remain in place for some time. All this government spending not only helps to navigate the short-term economic tempest, but creates opportunities for economies to transition or invest in the future, providing further comfort for investors.
We expect bumps on the road to recovery, and these are likely to cause market volatility. In the longer term, markets and economies should normalise as the pandemic is brought under control.
When investing, past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.