Market Update October 2020
What’s been happening over the past few months?
We thought markets had run too high during the summer months, when they continued to climb higher on the back of economies reopening faster than anticipated. Over the past few months Central Banks have remained very accommodative, which has also helped push markets higher to levels where they did look very expensive. We thought a correction would happen in the early summer, it came later in the summer, which at its worst in the space of 3 weeks through September, the US market was down a little over 10%. Globally, equities were down approximately 8%, but since then there has been a big rally and markets are not far off their late summer highs. Much of the fall has been recovered and the recovery has been driven by the change in the polls in the US Election.
US Election – Trump vs Biden
There has been a huge swing in the perception around the US Election in the past two weeks. Up to early October Biden was ahead in the polls but it was close enough. Some non-partisan analysists thought there was still a chance that Trump wouldn’t be far behind on Election day. If he was close enough when the final result was known there was a real possibility of a contested Election whereby he’d drag it through the courts. Potentially it could be a number of weeks before the outcome of the Election was known and that could cause some uncertainty. The first debate was a debacle but Biden came out a little bit on top in so far as he came across as the more, Presidential or Politician-like of the two. Within a matter of days Trump contracted Covid-19 and that resulted in a big change in the polls. This underscored how badly Trump and his administration have handled the whole Covid-19 pandemic. Some of his actions in the meantime have been off the wall in terms of what he has been doing and saying and for many that was the key turning point in the polls. Biden is now, in some of the National Polls about 16% ahead, in all the key “swing States” he’s ahead and in some of them he’s ahead by 10% or 11%. The smallest margin he is ahead in any of those key “swing States” is about 2% or 3% and even within the margin of error that still probably gives him enough for those “swing States” to ensure that he wins.
As outlined in our June Market Investor Newsletter we felt that Biden was going to win but not by much, now the sense is that he is going to have a big win, a big victory to the extent that Trump won’t even be able to contest the Election result and that’s taken out that huge uncertainty away. There is an increasing sense that the Democrats will win the Senate and with that they will have a clean sweep of The Presidential Office plus both Houses of Congress. They will be able to put through a big fiscal stimulus at some point in 2021. All the concerns about the slow place and inability to agree on any fiscal package before the Election, has been forgotten about. Even with potential Corporate Tax increases coming through, Dividend Tax increases and Capital Gains Tax increases, the markets are looking through that short-term impact and at the potential for a big fiscal stimulus from the Democrats in 2021. That’s why the market has moved as much as it has over the past few weeks.
In our September 2019 Investor Newsletter we discussed the growth in Environmental, Social, and Corporate Governance (ESG) Investing. If Biden wins, there is every possibility that he will follow through on his climate change agenda, which should give a boost to sustainable investing. If Trump wins, we may see environmental protections eroded further, or at least a continuation of the status quo.
Central Banks
The US Federal Reserve (FED) changed its inflation target recently to an average inflation target of 2%, which basically means they are not going to raise rates for a number of years. Officially the FED have said they are not going to raise rates until at least the end of 2023 and it’s probably going to be late 2024 if not 2025 by the time this happens. The ECB is also suggesting it’s going to review its inflation target, they may not change it in the exact same way as the FED but they will tweak it and that will mean that the ECB is going to remain very accommodative as well for the next few years. Before they review their inflation target the ECB is probably going to increase QE. The Bank of England have suggested they are willing now to think about going to negative interest rates and increase QE.
What could the future hold for Global Equity Markets?
With the recent move in markets higher they are not far off the levels they were at during the Summer so they look expensive again in absolute terms, but continue to look very cheap versus bonds and cash mainly because interest rates are so low.
When you review equity valuations metrics they look expensive. On a Price to Earnings basis (P/E) as of last night they’re about 19.6 times P/E 12 month forward but the long-term average is 15.7 times. Price to Book equities are trading at about 2.5 - 3 times but they’re long term average is about 2.2. Finally, the average dividend yield is about 2.02% but the long-term average is about to 2.52%, so any metric you look at equities look expensive.
There will be a strong earnings recovery over the next 2 - 3 years. Some analysts expect earnings to grow by 28% in 2021 and by about by 16% in 2022. However, we feel that these forecasts are too high and think one can take 7% or 8% off those earnings forecasts over the next two years.
There are a number of variables that can happen in the next 12 months but we feel on the basis of assuming conservative earnings forecasts about 7% - 8 % below consensus, over the next 2 years and assuming markets will trade at higher P/E multiples than we have historically seen (but can be justified due to the low bond yields environment), this still gives modest upside on a 12 month view for equities of 4% - 5%. We feel it is going to be very difficult to expect double digit returns.
In summary we feel modest up-side in equity markets of 4% – 5% is possible, but that all hinges on the global economy continuing to improve, albeit the pace of growth has obviously slowed from where it was during the summer months. The global economy will likely grow by 6% – 7 % on an annualised basis in Q4 compared to 35% in Q3 so all investors know that the pace of growth has slowed and next year will probably deliver growth of about 5%. As long as that continues to come through and as long as earnings growth comings through as anticipated we think there is an upside in equity markets albeit modest.
What Risks are ahead?
If a damaging second wave of Covid-19 infections emerge and a vaccine is delayed this will certainly be a cause for concern. Analysts are expecting a vaccine to be announced by the end of the year or in Q1 2021, so that it’s widely distributed to the population in Q2 or the middle of next year. If that happens that should allow activity to return to normal in the second half of next year. An additionally risk is if the Central Banks were to step back from the amount of stimulus they are providing. But we don’t think this is going to happen, in fact we think the opposite, particularly if the Democrats win through in the US Election, we’re likely to see an extended fiscal package coming through early next year. Some of the provisional budgets that we’ve seen in Europe suggest there will be reasonable levels of fiscal stimulus next year as well. Also the UK is talking about the need for further fiscal stimulus. As long as we continue to get these supports from a fiscal and monetary perspective we feel you will continue to see growth improve. Finally, the other big risk would be a surprise in the US Election and Trump is considerably closer to Biden than we expect. He may then contest the election and we don’t get an election result until the middle of December or early next year. If that happened then we think there could be another correction in markets around the time of the election.