When the Investment Strategy Committee ISC) met on 1 October it confirmed its three scenarios for the evolution of the pandemic. It is likely we will continue to live in a world of social distancing with more severe regional and local lockdowns in places experiencing upsurges in the disease.
We did not know then that US President Donald Trump now has the disease, but we reaffirmed the central role the virus still has in determining our economic future and the path of markets.
The outlook for world economies has been much damaged by the virus. We are looking at substantial declines in output and incomes for 2020, with the recovery in the second half of the current year continuing into 2021. As we feared before, most countries will fail to get back to February 2020 levels before the end of 2021, such was the damage done by the lockdowns.
China bounces back
China was first out of the crisis and should grow rapidly next year after expanding around just 2% this year. The US will grow more quickly than the European economies, assisted by a massive Federal Reserve stimulus and the success of US technology businesses. Germany will perform better than France, Italy and Spain in the Eurozone – as it suffered less damage from the virus and entered the downturn in good financial shape allowing a fiscal boost. This year will see a loss of output and income of between 5% and 10% in the main advanced countries.
Equity markets since the end of March have performed well, thanks to the massive liquidity injections from all the leading central banks. There has been little or no general price inflation, but there has been substantial asset price inflation. There has been a growing gap between the prospects for profits and earnings for much of the global economy and the share prices. We have also witnessed a large increase in the share prices of those sectors and companies that can survive and thrive in these difficult conditions, especially those that use or provide digital technology.
The US is currently at a crossroads. The choice between President Trump and candidate Joe Biden is a dramatic one which will result in very different outcomes. A Trump Presidency means a belief in cheap fossil-fuel energy, a larger US oil, gas and coal sector, lower taxes, less regulation of business, - and a tough tariff policy against countries Mr Trump thinks are cheating.
A Biden Presidency would seek higher taxes, more regulation of business, a major change of direction on energy with a big switch to renewables and hostility towards carbon-based fuels, more wish to work with allies and international bodies – and a further move to higher welfare and state health spending. The two agree on few things. Both see China as a competitor and threat that needs to be called out. Both will seek to control the virus and foster growth though in different ways.
A Biden win is the more likely outcome. The polls have consistently shown him with a decent lead in the national polls, though the polls in the crucial swing states have tightened and many are now too close to call. It is also possible the Democrats could win a narrow majority in the Senate, whilst it is very unlikely the Republicans could win the House of Representatives back. It is therefore the case that we need to plan for a possible full-throttle Democrat government under Biden, or for a Biden Presidency where a Republican Senate provides some constraint on parts of the programme. The Senate would seek to limit tax rises and veto some extra spending.
There are three scenarios for the virus
The optimistic one is the world produces one or more vaccines that work and are rolled out quickly, allowing many of the restrictions to be dismantled relatively early in 2021. This is not very likely to happen quickly, given the massive task of vaccinating most of the world successfully even if the perfect vaccines turn up.
The base case is the virus lingers, with governments using local and regional lockdowns and some background national controls that fall short of a comprehensive lockdown. The modest recovery struggles to get back to the starting position because travel, leisure, hospitality and entertainment remain damaged and reduced.
There are a series of worse cases, ranging from dangerous flare-ups in the virus with significant national lockdowns again, through to the fiscal and monetary authorities failing to sustain sufficient stimulus to compensate for the virus damage.
The digital revolution has been greatly speeded by the pandemic effects. The big switch to online “everything” for individuals and businesses has left many city centre shopping areas blighted by a shortage of customers – and left many office centres without daily commuters to spend money and give them life. It looks as if many of the market-share gains made by online shopping, remote working, downloaded entertainment and the rest will be held even when controls are relaxed.
The green revolution is very popular with governments
Were Biden to win in the USA and President Xi to see through his stated plan to make dramatic changes in energy sources and uses in China there will be big top down changes in the world economy. There will be plenty of opportunities for investors in batteries, renewables, electric vehicles and the other products of the movement. This also reinforces the search for digital solutions as an alternative to jet flights and car journeys.
The green revolution comes at a price with the prospect of major write offs in fossil fuel energy, traditional vehicles and carbon-based industry. Low interest rates are likely to continue well into the future in the advanced countries, causing pressure on bank margins and profits. Many businesses in the areas hit by social distancing and closures are weakened and will need write offs and new capital to survive. This needs to be handled without causing panic in debt markets.
There will be plenty of debt downgrades, and much new money needed to rebuild buffers and provide liquidity. So far, this has been present – with the result that high yield debt has moved back u-p again away from the worried levels of March. Any wavering in central bank support for markets could lead to weakness in debt markets, as fears would grow about solvency.
As a result of this analysis, the Committee recommended a neutral position on equities, downgrading US shares from “positive”, given current high valuations and election uncertainties. It left the emphasis of bond portfolios on Treasuries and gilts, thinking it too early to recommend high-yield bonds, given the stresses on the corporate sector from lost revenues and poor demand.
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Charles Stanley investment strategy update
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