Market Update - 30 September 2020

30 September 2020
Investing involves the risk that your capital goes down as well as up; you may get back less than you invested. The commentary below is not intended as a recommendation for you to personally buy or sell any of the investments mentioned nor to take any investment action whatsoever.

Hello everyone,

There has been a lot to digest since I last wrote to you in April but I think the key points are:

1. ​Central banks, especially the Fed, gave huge support to asset prices by printing more money
2. ​Global stocks rebounded back to their all-time highs

The two key points are clearly related: there is far more money in the system. Therefore that money is worth less than it was (supply and demand). Therefore things that are valued in money terms (like stocks and houses) are worth more. It really is that simple.

There has been more nuance under the surface. 

Tech stocks - as epitomised by the NASDAQ - have performed exceptionally well. This makes some sense fundamentally: we watched a lot more Netflix in the spring and did a lot less flying around the world. But the price of tech (and ‘growth’) stocks was also pushed up by the higher likelihood that interest rates will stay even lower for even longer. The cost of money - the ‘opportunity cost’ of investing - declined and, therefore, investors quite logically ascribed relatively more value to companies that they believe will pay off handsomely at some point in the future (because the cost of investing in them declined).

So stocks have risen since March and it’s been tech/growth stocks that have led the way; and while we might quibble about the extent to which the rise has been driven by fundamentals or monetary stimulus, it’s clear enough that the outperformance of tech/growth logically had made sense.

So what happens next?

I think there are four broad ways to conceptualise the future path for stocks:

1. We get another panic / selloff this winter. While there are always a myriad of risks on the horizon, the largest I see is the most obvious one: that the coronavirus resurgence this winter is much worse than the market currently thinks. If such a scenario develops, it will almost certainly be a buying opportunity as these deflationary shocks have, historically, always been excellent buying opportunities (March being the most recent example). 
2. We continue to get this quasi-recovery where the winners (e.g. tech/growth) continue to win but most other stocks fail to regain their previous highs. Since growth is scarce, investors flock in droves to the companies that are showing some growth. My belief is that monetary stimulus is one of the keys to this environment; which helps to explain why it has been by far the most successful investment ‘style’ of the post-2008 years.  I’m not (yet) convinced that this environment is over, though it could be ending - or at least pausing - soon.
3. A healthy reflationary environment where real economic growth improves. I think - and I certainly hope - that this is the next step in the world’s journey out of this pandemic. In this scenario, the winter wave is managed relatively successfully and any subsequent waves become ever smaller. In this environment, we are booking international travel again, going into our offices and meeting people in-person instead of on Zoom. I don’t know exactly when this day comes but I strongly believe it will come; I believe it is just a question of timing.
4. An unhealthy inflationary shock where the cost of things increase (driven, perhaps, by higher commodity prices) but economic activity doesn’t rebound much. This scenario would be painful for most investors, although certain areas of the stock market would likely do significantly worse than others. 

I am skeptical of an inflationary shock developing anytime soon; I simply think that the damage done to the global economy will take at least a few years to rebuild. That spare capacity probably needs to be filled before we experience enough demand to propel commodity prices far higher and for inflation to be sustained above 2%. Though I remain wary of the risk as it would likely be very painful for the price of most financial assets.

The big question for me is when we will experience a healthy reflationary environment. I am skeptical that it will be this winter largely because it is in governments’ (and most people’s) near-term interests to suppress the virus - and therefore measures that suppress both the virus and the economy will increase as the positive test count naturally grows as we all move indoors during winter. Nevertheless, the market usually does a good job of looking 6 or so months’ ahead - so, unless the situation gets especially dire, the market will be keen to price in a recovering environment in spring/summer 2021 sooner than later. Again, for me it is not a question of if a recovery begins getting priced in, it is when.

When we get a reflationary environment I expect tech/growth stocks to underperform most other stocks. To return to a simple example, in a world where flying becomes popular again, owning an airline at a depressed valuation is probably a better idea than owning a streaming service at a historically high valuation. I would therefore caution investors to ensure that their portfolios are not overly loaded with ‘growth’ type stocks and that there is room for more reasonably priced companies as well. In my view, there is now significant value available in equities, though not necessarily in the most popular companies. 

Some other tangible points: our clients are neutrally positioned (i.e. in line with their mandates) with regards to equities. Therefore if we get a stark selloff, we have the ammunition to rebalance (i.e. buy stocks). If we get such a selloff we will likely move to ‘overweight’ equities, especially if the selloff is due to the coronavirus. We have mostly sold out of the short-dated IG bonds we bought in early April and swapped the exposure into both cash and 'market neutral' equity funds (this is particularly true for UK orientated investors). 

As ever, I hope all of this is helpful in some way. Please feel free to get in touch if you would like to discuss it further. 

With my best wishes,
Scott
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Scott Tindle, CFA is the Founder & Director of Wealth Management at Tindle Wealth Management

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