Review of the Week: Sliced and diced

^{Source: FE Analytics, data sterling total return to 16 October}

The pandemic subsumes all

Most stock markets posted gains last week – with the typical exception of the UK, that is.

Economic data, in general, has been mixed, while the second wave of COVID-19 (and, in some cases, third wave) continues to roll worryingly through communities all round the world. In the US, Europe and UK, deaths and hospitalisations are rising, but at nowhere near the rate of reported cases. This is a good sign, at least. Albeit not one that should make us complacent, however. Governments in Europe and the UK have started ramping up commercial restrictions once again, which will create yet another headwind for businesses and employment.

Analysts had factored in this bumpy present months ago, so the third-quarter company reporting season in the US and EU has a low bar to clear. American stocks are forecast to post an average 22% fall in profits compared with a year ago, while their European counterparts’ earnings are expected to drop 34%. These numbers may well turn out to be too conservative, but, even if companies overdeliver, estimates of their 2021 earnings have yet to be reined in from what we believe to be pretty optimistically high levels. The backdrop for Europe in particular deteriorates daily as new COVID cases rise and more countries put in place tighter lockdown restrictions.

"Most stock markets posted gains last week – with the typical exception of the UK, that is."

The hope that we’re on the cusp of turning the tables on the virus and that a full-throated recovery is right around the corner is ebbing once again. Tied to the hip of that hope go the fortunes of the more ‘cyclical’ companies – those whose profits are more sensitive to changes in GDP growth. These businesses, which generally include banks, factories, retailers and airlines, have retreated from recent, short-lived resurgence. Companies that are less reliant on improving economic growth for their profits – many large technology businesses, utilities and healthcare providers – have since resumed their outperformance.

We often talk about how we believe that we are in a world where growth will remain hard to find and interest rates should remain low for a long time . We think investors are more likely to pay up for more reliable growth companies in such an environment, which is why we think it makes sense to have a bias toward defensive, higher-quality companies . This was brought into sharp focus at the weekend’s G30 virtual meeting, with various central bankers including Bank of England Governor Andrew Bailey highlighting the unprecedented level of economic uncertainty, and noting the recent rise in new virus cases around the world. 

So why were British stocks weak? Same old reasons really. Prime Minister Boris Johnson had another tough week, with northern political leaders – including some conservatives – banding together to refuse support for tighter lockdowns in their communities unless the government comes up with more financial assistance for furloughed workers and shuttered businesses. Meanwhile, the Brexit negotiations came to yet another impasse. Mr Johnson threatened to walk away from negotiations because of the longstanding disagreements over fisheries and state aid. To top it off, the credit agency Moody’s cut the UK’s rating by one notch to Aa3, citing lessened prospect of economic growth and a weakening of British institutions and political governance.

In some ways, the worse the pandemic gets in the UK and the Continent, the more likely that both sides will compromise on Brexit and hammer out some sort of deal to minimise the damage to their economies. It shouldn’t have to come to that though. We hope reason will prevail on both sides of the Channel.

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Bonds
UK 10-Year yield @ 0.18%
US 10-Year yield @ 0.75%
Germany 10-Year yield @ -0.63%
Italy 10-Year yield @ 0.65%
Spain 10-Year yield @ 0.12%