The global economy continued to recover during the third quarter after many developed countries suffered their biggest falls in quarterly GDP on record in the second quarter. Global economic activity data for the summer months rebounded as restrictions were eased and most economies were allowed to reopen. Governments and central banks from across the world remained supportive towards the needs of businesses and consumers. However, despite positive news surrounding potential vaccines and better treatment outcomes, a resurgence of virus cases in the US and Europe scuppered any hope of a rapid return to normality for the global economy.
Global investor sentiment stayed fairly positive during Q3 despite a bleak (albeit recovering) global economic backdrop and a resurgence of virus cases in many developed countries. The majority of stockmarkets continued to rise following the remarkable rebound in performance seen in the second quarter, immediately after March’s COVID-19-induced sell-off.
In the following paragraphs we provide a high-level overview of how some of the main constituent asset class of PruFunds have performed over the third quarter.
The UK equity market lagged many others during quarter. Investor confidence being undermined by concerns about Brexit, the withdrawal of £38 billion of dividends in the first half of the year and a resurgence of COVID-19 cases. Larger exposure to banks and the energy sector and a smaller technology sector than other countries, particularly the US, was a further drag on overall returns.
US stockmarkets enjoyed another good quarter despite a weaker period in September. As businesses reopened, improving economic data and support from the Federal Reserve, led to strong returns in July and August, with gains led by the technology sector. In September concerns that further lockdowns could hamper economic recovery, uncertainty about the presidential election, a lack of agreement on further economic support and the high valuations of technology companies did stall markets.
Overall, Asia ex Japan equities had a positive quarter, with optimism about the economic recovery outweighing worries about COVID-19. The Chinese stockmarket was one of the main drivers of returns, as economic activity continued to rebound from the COVID-19-induced slowdown. The Taiwanese and South Korean stockmarkets also outperformed, helped by their sizeable exposure to technology companies. Some South Eastern Asian markets lagged, including Indonesia, Philippines, Singapore and Thailand.
As announced in the Groups half year report, the Asian equity team within M&G were awarded the mandate to run Asian equity portfolios within PruFunds. A thorough due diligence process was undertaken by the Manager Oversight team within T&IO with M&G replacing Eastspring Investments.
Europe – Neutral
European equities ended the third quarter flat as the rebound lost momentum. A resurgence of COVID-19 infections sparked worries about the economic recovery, while uncertainty over the agreement of a Brexit trade deal also dampened sentiment.
Corporate bonds +ve
The impact of the coronavirus pandemic and the huge stimulus packages from many central banks to counter it are still key to global bond market returns. Interest rates remain at low levels and bond-buying programmes in government and corporate debt markets has continued, which has been supportive. Yields on 10-year US Treasuries fell to a historic low of 0.5% in early August, before edging up to 0.7% at the end of September, while 10-year German bund yields remained in negative territory.
With core government bond yields remaining close to their historic lows corporate bond markets had a good quarter as investor confidence returned. The largest PruFund exposures are investment grade corporate bonds across the UK, Europe, US and Asia so this was beneficial.
UK commercial property capital values fell in July and August (September data was not available at the time of writing) according to property consultant CBRE. However, including rental income UK commercial property recorded a small positive return.
Industrials was the only sector to report capital growth in July and August, reflecting ongoing demand for regional and national distribution centres. Retail capital values continued to fall but this has been a trend since the start of 2018, driven by the continued growth of e-commerce and the failure of some traditional retailers. Capital values in the Office sector also fell, but the pace of the decline eased compared to the second quarter.
PruFund portfolios also invest in property across Europe, Asia and the US and many parts of these portfolios have continued to show resilience in challenging markets.
Notwithstanding the short-term challenges we do believe events this year have brought some key themes such as e-commerce, the emergence of the private rented residential sector and ESG into sharper focus. We believe that positioning portfolios to capture these themes will prove to be positive for returns in the long-term.
The prospect of a second spike in infections has been ever present since lock down measures were eased and this appears to be happening in many areas. This is obviously worrying and causes more uncertainty.
We do believe that progress has been made in understanding the illness and as a result, treatment of cases appears to have improved with fatality rates falling as a result. The measurement of fatality rates remains imperfect with it thought to have been around 3% of total cases globally. Our research suggests the fatality rate is now closer to 2% and in some regions like Europe, has fallen below 1% in recent weeks. This fall could be attributed to demographics, as more new cases appear to have been in younger age groups since the easing of lockdown.
As ever speculation is rife around potential vaccines and we believe progress has been made. Several candidates are in advanced stages of trials and have exceeded prior expectations. The process would normally take years but thanks to a unified global push there are currently 7 vaccines in the advanced stages of trials. However, it remains unlikely that a vaccine will be widely available before Q2 2021.
The US Presidential Election
With the 3 November fast approaching and the polls suggesting a victory for Joe Biden, we are reminded that in 2016, Hilary Clinton was the clear front runner for much of that campaign.
With two Presidential debates to come and new economic and virus-related data important factors, any good news on either could still influence the outcome. What is likely, is a delay in the final result with around 80 million people expected to vote due to concerns over long queues and virus transmission.
A change of president, particularly if the Democrats win both houses, will very likely see increased taxation, a change in foreign policy and a greater commitment to tackling environmental issues. This potential change in fiscal policy will likely get a mixed reaction from markets as the positive message around stimulating growth is offset by negativity over higher taxation.
Interestingly, both candidates support the US-Mexico-Canada trade deal and some form of tariffs on goods from China.
Brexit rhetoric has continued with the 15th October Boris Johnson-imposed deadline for a deal upon us. The European side have stated they were prepared to let negotiations slide into November and December while Mr Johnson reiterated his deadline. Despite this impending risk, there has been some positive commentary about good progress on talks recently, which has supported the pound against a challenging backdrop.
If we reach the December 2020 deadline set out by Boris Johnson without a trade deal the UK will become a “third country” and EU law will cease to apply to the United Kingdom. This will have implications for the UK economy but as we noted recently as we noted recently a lot of negative news and Brexit risks have been reflected in the performance of the UK stockmarket for some time now.
Markets will continue to be sensitive to COVID related news. We saw only recently a large daily fall in the FTSE 100 driven by expectations of stricter lockdown rules in the UK. These periods of uncertainty and investor nervousness will likely re-occur. As ever, trying to time markets and be precise on a timeframe for a return to normality is virtually impossible so it is important to try and balance portfolios to be robust in the short-term whilst still looking for long-term opportunities as capital markets evolve.