From One Market Cycle to the Next? - T&T Quarterly Market Update - Q2 2020
by Thomas Quinn on Jul 10, 2020
Reading Time: C. 8 mins
Composing quarterly market updates are a cathartic pastime for me. Now into the 6th year writing these, I follow a system of reviewing the quarter by numbers followed by sharing a few stories or themes that affect the underlying financial markets. These past two quarters have danced between the sharpest panic sale in the market in 100 years followed by the best 50 days in the market ever. These events ironically make writing these harder.
Who wants to digest another deep dive on COVID-19, testing, spikes, 1st wave, 2nd wave, etc.?
It’s been a hyper analysed and heavily reported 6 months of COVID-19. In an attempt to avoid the obvious, I focused on some auxiliary events and stories that may specifically affect you, our clients. But first, as always, I look at the Quarter in Numbers.
Before I begin, I want to remind everyone that the 2019 tax season deadline is on 15th July.
Quarter in Numbers
As global central banks and governments open the coffers, print nearly endless currency, and economies open up from a sustained halt to life as we know it, the broad economic data has rallied. This quarter has been strong for equities, bonds and risk hedges like gold.
Looking to the developed markets, the S&P 500 is +20.5%, the MSCI Europe (ex-UK) is +15.1%, the FTSE all-share is +10.2% and Japan TOPIX is +11.3%.
We have seen a similar theme across emerging markets (EM) and global real estate (REITs) with MSCI EM +18.2% and Global REITs +10.8%.
The fear of a liquidity crisis - businesses and governments not being able to access the cash they need to keep their companies and countries alive - appears to have gone and there’s no appetite at this time for central banks to stop providing the cash necessary to keep their economies alive. What happens with the ensuing debt is a topic for another quarter.
What has been notable though is governments are lending, not spending, so your business can borrow to meet the necessary liquidity needs given the economic pinch. However, the government will not be stepping in to buy businesses in financial disrepair. A trend over the coming quarters will be a rise in bankruptcies and some big names will fall, and a few have already.
Risks still exist, despite this spending, especially in a number of developed countries where the governments will stop lending on such a scale soon. There’s been incredible inroads made into a vaccine, however, don’t get in the queue for CVS just yet, with early 2021 being touted as the most likely time a vaccine might be ready. I’m no infectious disease expert, so this still might be optimistic thinking! And we have an election and that Brexit thing still to look forward to in the second half of the year.
Although we entered the quarter with uncertainty, it ended up being unforeseeably positive.
Source: Standard & Poor’s, MSCI, FTSE, TOPIX, FTSE, NAREIT Global Real Estate Investment Trusts
Cash on the Sidelines
Trillions were pulled out of the stock market in Q1 and a lot of that money still remains in money market or cash deposit accounts. For the first time ever money market assets broke through the $4 billion barrier to around $4.8 billion today – in 2008 the $4 billion barrier was not broken.
According to FDIC, US banks saw a $2 trillion cash surge in bank deposits, and the personal savings rate (the amount people are saving as a % of disposable income) hit a record 33%. This high cash inflow shows us that many investors jumped out of the market when volatility hit and haven’t yet got back in.
With the Federal Reserve confirming that the federal funds rate will remain at or near 0% through 2022, there’s not much hope for a return on cash for those investors. And for those investors, the market volatility could have spooked them enough to keep their money out for a number of years.
So the pattern returns to what we saw in 2008 when cash inertia set in for thousands of investors and retirees reticent to jump back into equities, this resulting in permanent and long-lasting damage in their investments and retirements as losses became permanent and the stock market continually ticked higher and higher whilst they sat on the sidelines.
For those begging for a different headline from the UK, they certainly got their wish with COVID-19. Brexit appears to be a lost story in a pandemic, but it shouldn’t be forgotten as the future trading relationship with the EU will sculpt the UK’s future far more than this virus.
It’s a big topic for us, and for a number of our clients as it’s a large stimulant driving the strength (or apparent weakness) of GBP which we rely on to run our business, and clients rely on to fund their retirement!
So, I’ve scrabbled around the Brexit specialists and reporters to provide us all an update.
In early July, Michel Barnier is due at 10 Downing St. to meet with David Frost (UK Negotiator) and presumably a small army of UK/EU negotiators. Both parties have a deal at the forefront of their plans, and neither side can afford two economic shocks in the space of 2 years. And if you want a flutter, then the bookies agree, with odds on a deal being the favourite at evens.
What’s holding up the deal? Or the ‘red-lines’ as Boris has put it:
- UK wants to control its waters and only allow UK trawlers to fish
- UK wishes to control the rules of engagement when it comes to trade with other countries.
- EU wants a ‘level-playing field’ when it comes to UK following EU Court of Justice laws on environment, labour, taxation, or state aid. Meaning the UK must follow these EU laws as to not create a competitive advantage over any EU countries.
The EU rhetoric is towards striking a ‘bold and ambitious agreement’ and they are very much intent on moving forward. Downing Street is still echoing preparations for a no-deal in order to create leverage with the EU. That may be working as Michel Barnier and the less hard-line EU countries have dabbled with easing the fishery laws, much to the distaste of Emanuel Macron.
GBP has fallen against EUR in recent months, partly as the UK was hit harder than any other EU country with COVID-19, but also because the clock is ticking and rationale negotiations are still a fallacy.
If the UK falls out of the EU with no deal then that would be an initial disaster for GBP. It’s not that likely but this is politics and emotion we’re trying to predict. If the UK agrees to a deal similar to what’s on the table then expect some rally in Sterling. However, this deal is anticipated so we’re not expecting a rally to the long term mean of £1:$1.50.
The UK has a debt issue, but not on the same scale as the US debt crisis. Looking at these in isolation, this is positive for GBP and we’re somewhat optimistic for GBP over the long term. However, until we know the how the UK fits into the global economy GBP will remain in relative weakness.
Is This Normal?
We have had a handful of conversations with clients over the last 12 weeks saying something to the effect of ‘this isn’t normal, it’s not anything like we’ve seen before, I think we should sell out’.
I have to agree, few of us would have imagined living through a global Pandemic like COVID-19. It would appear like nothing is ‘normal’ right now.
So, if this is an abnormal time, what does a ‘normal’ market look like?
Looking to the S&P 500, the average annualised return is 10% (1926-2019) however, it has only been between 8%-12% on 6 occasions in the last 90 years. It’s equally as likely to finish between 19-21%. And yearly returns have ranged between +54% and -43%.
What this would suggest is that the average is not the normal. The only trend, when you view the stock market from one year to the next, is volatility and unpredictability. If the last 90 years tells us anything it’s that it's perfectly normal for the stock market to move in a number of ways from each year to the next.
The previous two recessions were equally as unique and abnormal. Recessions by their nature have to be unique and unexpected in order to cause the panic and disturbance that push investors to pull out of the market and businesses to stop spending.
Right now, stocks might feel too risky and bonds and cash might feel like the safer alternative. However, stocks behaving this way is totally normal, and we can be certain, looking over history, that they will always act this way.
If you hold cash or treasuries in this market today, you’ll lose money in relation to inflation and don’t forget healthcare costs in the US rise by 5%-6% per year! History tells us the stock market will always be a risky place, but if you can manage this risk and not focus on the year-year volatility you will be handsomely rewarded.
And finally, if you are thinking of making any changes, I would urge you to think back to January 1 of this year. Have your most cherished lifetime financial goals changed since then? If not, I see no compelling reason to change your plan—and no reason at all to change your portfolio.
By all means, please be in touch with any and all questions and concerns. In the meantime, thank you—as always—for being clients of Taylor & Taylor USA.
If you're not a client and you want to find out how we could help you if you live in the USA having formally lived in the UK, please get in touch on +1 646-201-4865 or email@example.com
Taylor & Taylor Financial Services USA LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.