Market and Economic review for week ending 11 September 2020
Current tactical positioning
For funds in which we take TAA positions, we maintain our overweight in high yield credit as the technical environment is still favourable. The volatility seen in equity markets over the last few weeks has not presented itself in credit markets to the same degree. We note that credit spreads have contracted since March, but we see more upside in high yield bonds compared to investment grade bonds given the hunt for yield within fixed income markets. At present, we retain a neutral view on equities and continue to follow the trajectory of the virus and associated knock on effects of lockdown measures. The portfolio managers continue to hold a small position in UK REITs across all the Prudential Risk Managed Active and Risk Managed Passive portfolios.
Market and Economic review
While the week started off with modest gains for Asian and European equity markets, this was partly a function of lighter volumes due to the US Labor day holiday. The down draught recommenced when US markets opened down, with stocks such as Tesla suffering its biggest daily percentage drop (-20.2%). The technology heavy Nasdaq has had an outstanding year-to-date, up ~42% before the more recent contractions (vs +11% for the S&P). This has led to intense debate in the market with many “explanations” such as; a momentary dip due profit taking; worryingly increasing options activity (with Softbank being a large buyer); and others who believe there is a bubble in tech stock valuations. Midweek, the 3-day losing streak was broken as equities staged a small bounce back amid elevated intraday volatility. On Thursday alone, the S&P wiped out a gain of 0.8%, to be down nearly down 1% within a few hours. Interestingly, as equity markets whipsawed, credit markets were broadly stable (US HY spreads widened +1.8bps and European HY credit spreads fell -8.9bps). Long dated US bond yields rose, reflecting the risk-off mood and after government auctions of 10-year ($35bn) and 30-year notes ($23bn) were met with soft demand (with slightly more appetite for the 30 year notes). The US Treasury has been increasing the size of its auctions across the curve as it pays for stimulus meant to boost the economy after the COVID-19 lockdown.
The euro strengthened further this week (against most G-10 currencies), particularly after comments from ECB President Christine Lagarde. What can be seen as a relatively relaxed stance towards the euro strength has helped to drive the EURGBP to over 0.92, its highest level since March. She specifically noted that there was no need to over-react to the recent appreciation of the euro, indicating no imminent changes to monetary policy. European equities have been pegged back by euro strength and overall global equity jitters. A strong currency is a headwind for Europe’s globally diversified listed corporate sector. On top of this, Western Europe surpassed the US in new daily COVID-19 infections, re-emerging as a global hot spot after bringing the pandemic under control earlier in the summer. The 27 countries in the European Union plus the U.K., Norway, Iceland and Liechtenstein recorded 27,233 new cases on Wednesday, compared with 26,015 for the U.S. This follows several weeks of resurgent infections in Spain, France and other countries across the continent.
Mix a stronger euro with renewed Brexit tensions and you have the perfect recipe for sterling weakness. The EU gave the UK until the end of the month to amend the Internal Market Bill which it said violates the Brexit Withdrawal Agreement. Boris Johnson looks ever increasingly willing to run negotiations down to the wire, and risk a hard Brexit. Having touched $1.34 in early September, GBPUSD has dropped nearly 4% in September (-3.8% for GBPEUR). The FTSE 100 has benefitted from the sterling weakness up ~+3.77%. In other data, US job openings increased further in July, though more workers quit their jobs in the retail as well as professional and business services industries potentially because of fears of exposure to COVID-19 and problems with childcare. Despite the surge in vacancies reported by the Labour Department in its monthly Job Openings and Labour Turnover Survey, or JOLTS, the number of unemployed people competing for new jobs remained relatively high in July.
In Japan, the economy sank deeper into its worst post-war contraction in the second quarter of 2020 as COVID-19 jolted businesses more than initially thought, underscoring the daunting task faced by the new Prime Minister. The country’s economy shrank 7.9%over Q2.
Although we have not taken a position, the team have been discussing the potential headwinds for sterling, namely: deterioration of Brexit negotiations, increasing COVID-19 cases in UK (although Europe is also increasing), euro strength likely to persist, and USD weakness potentially having run its course.
Next week’s data releases include US, Japan, Italian and UK inflation, US Empire manufacturing and Japanese industrial production.
T&IO Weekly Market Update Podcast
Mark Riggall, Head of Client Portfolio Management at T&IO talks through this weeks latest market developments and T&IOs current outlook.