A selection of articles looking back through the markets last month.
Global Market Review
Share price rises defy an uncertain outlook
Global share prices generally rose during August as investors took heart from ongoing fiscal and monetary support alongside some encouraging economic data. Nevertheless, the global economic outlook remains “highly uncertain”, according to the World Trade Organisation (WTO), which expects the recovery to follow “an L-shaped, rather than V-shaped, trajectory” against a deteriorating trade backdrop. Meanwhile, the price of gold breached US$2,000 per ounce for the first time in response to speculation over the economic impact of the Covid-19 pandemic and continued uncertainty over the worsening relationship between the US and China.
“The UK economy went into recession for the first time since 2009”
In a bid to provide more flexibility for policymakers, the Federal Reserve (Fed) announced a “robust” update to its inflation targeting policy. Instead of aiming for a fixed target of 2%, the Fed will now aim for an average inflation rate of 2%, allowing it to run “moderately above 2% for some time”. The Fed believes that the pandemic is likely to continue to “weigh heavily” on the economy in the near term, whilst presenting “considerable risks” in the medium term. The Dow Jones Industrial Average Index rose by 7.6% over the month.
The UK economy went into recession for the first time since 2009: having shrunk by 2.2% over the first three months of 2020, the economy contracted by a record 20.4% during the second quarter. The Organisation for Economic Cooperation & Development (OECD) reported that the UK had been the worst-affected of the G7 economies over the three months to June. Brexit negotiations showed little progress during the month, and the EU’s Brexit negotiator, Michel Barnier, said that a deal “seems unlikely”. The FTSE 100 Index rose by 1.1% in August.
Around Europe, fresh outbreaks of infection forced countries to reimpose restrictions in a bid to stem the spread of the virus. Nevertheless, business sentiment in the eurozone improved in August – particularly in the services sector – and companies became more optimistic about the economic outlook although, according to the European Commission, sentiment continues to run below the long-term average. The Dax Index rose by 5.1% during August.
Japan’s economy contracted at an annualised rate of 27.8% during the three months to June, posting its third consecutive quarter of negative growth. Elsewhere, Prime Minister Shinzo Abe announced his resignation on the grounds of ill health. Nevertheless, over August, the Nikkei 225 Index rose by 6.6%.
Emerging Markets Review
India’s economy contracts sharply
As the pandemic took its toll on economic activity, India’s economy contracted by 23.9% during the three months to the end of June. The only sector to achieve positive growth during the period was agriculture, forestry & fishing, which grew by 3.4%. Although India is not officially in recession, it is widely expected to post a second consecutive quarter of negative growth in the three months to September as Covid-19 cases continue to climb. The CNX Nifty Index rose by 2.8% over August.
“China’s Premier Li Keqiang said that China is well-placed to deliver positive growth this year”
During the month, China’s Premier Li Keqiang said that China is well-placed to deliver positive growth this year if, as planned, nine million jobs are added to the economy, and urged the country to consolidate and build on recent positive economic growth by addressing uncertainties in the development process.
China’s exports rose at an annualised rate of 7.2% during July, supported by strong demand for medical products, while imports fell by 1.4%. In comparison, exports rose by 0.5% during June and imports climbed by 2.7%.
Factory activity expanded for a third consecutive month during July as strong domestic demand outweighed lacklustre overseas markets. Although producer price inflation fell by 2.4% year on year in July, the pace of decline slowed from 3% in June, suggesting that activity is continuing to improve. Meanwhile, the rate of consumer price inflation strengthened from 2.5% to 2.7% in July, partly boosted by higher prices for pork. However, having fallen by 1.8% in June, China’s retail sales continued their decline into July, posting a drop of 1.1%, suggesting that consumers remain reluctant to spend in the wake of the pandemic. During August, the Shanghai Composite Index rose by 2.6%.
Brazil’s rate of consumer price inflation showed signs of slowing from July to August, easing from 0.3% to 0.23% and dampened by lower educational costs and a fall in travel costs. On an annualised basis, however, inflation picked up to 2.28%. Nevertheless, central bank policymakers are not expected to make a move to ease interest rates further; the Copom works to a target inflation rate of 4% within a range of 2.5% to 5.5%, and the key Selic rate stood at 2% at the end of August, compared with 6% a year earlier. The Bovespa Index fell by 3.4% during August.
Europe Market Review
Three key challenges for the ECB
Amid signs that Covid-19 infection rates were on the rise once again around Europe, some localised restrictions were reimposed in August, putting a brake on economic activity. Having picked up in July, economic activity lost momentum in the eurozone during the first half of August, according to IHS Markit, as a strengthening manufacturing sector failed to offset a slowdown in services. The Dax Index rose by 5.1% during the month, while the CAC 40 Index climbed by 3.4%.
“Germany’s GDP has declined more quickly and strongly than during the financial crisis”
Business sentiment in the eurozone improved during August, led by the services sector, as companies became more optimistic about the economic outlook. Nevertheless, the European Commission reported that sentiment remains below the long-term average. Meanwhile, the Ifo Institute found that business sentiment in Germany is continuing to improve and reported that the country’s economy is “on the road to recovery”. German companies expect coronavirus-related restrictions on public life to continue for an average of 8.5 months. Service providers anticipate 8.9 months; trade 8.6 months, construction 8.2 months, and manufacturing 7.8 months. The most pessimistic subsector was leisure, which expects restrictions to last for 13 months.
Germany’s GDP has declined more quickly and strongly than during the financial crisis of 2008/09, according to Germany’s Federal Statistical Office, which reported a 10.1% contraction during the second quarter. Germany’s economic development has been “abruptly slowed” by the pandemic, which has also affected the labour market.
German factory orders rose sharply during June, posting month-on-month growth of 27.9% compared with May’s growth rate of 10.4%. On an annualised basis, factory orders declined by 11.3% following May’s drop of 29.3%, although volumes remained subdued compared with pre-pandemic levels. Across the eurozone, the manufacturing sector posted its first increase in production since the start of 2019 during July, according to IHS Markit, although demand was dampened by ongoing weakness in international trade.
Speaking at this year’s “virtual” Jackson Hole symposium, the European Central Bank’s (ECB’s) Chief Economist Philip Lane outlined three key challenges for the ECB: to stabilise markets; to protect credit supply; and to neutralise the pandemic-related downside risks to the inflation path. However, it will be necessary to address the first two challenges in order to achieve the central bank’s inflation aim, as it is “problematic” to operate an effective monetary policy against a backdrop of market instability or a credit crunch.
Global Bond Market Review
The Fed’s new approach
The US dollar weakened against the pound and the euro as Federal Reserve (Fed) Chair Jerome Powell announced a new inflation strategy designed to give central bank policymakers more flexibility by allowing interest rates to remain lower for longer. Rather than focusing on a fixed target of 2%, the Fed will aim for an average inflation rate of 2%, enabling it to run “moderately above 2% for some time”.
“German government bond yields climbed to their highest level since the start of June”
The ten-year US Treasury bond yield rose from 0.55% to 0.72% during August. Meanwhile, German government bond yields climbed to their highest level since the start of June following the Fed’s announcement, and the yield on the ten-year German government bund increased from -0.53% to -0.40% over the month.
At the annual Jackson Hole symposium – held virtually this year in response to the coronavirus pandemic – Fed Vice Chair Richard Clarida said that there are no plans to tighten policy in response to a recovering labour market, and also maintained that the Fed is not considering yield curve control.
Credit ratings agency Fitch affirmed its sovereign rating for the US at “AAA”, citing structural strengths including the size of the economy, high per-capita income, a “dynamic” business environment, and the US dollar’s status as the world’s preeminent reserve currency. However, Fitch downgraded its outlook for the US from “stable” to “negative”, reflecting the continued deterioration in the country’s public finances and the absence of a “credible fiscal consolidation plan”.
Having risen sharply at the start of the Covid-19 pandemic, the pace of sovereign downgrades and “negative” outlook revisions has eased considerably since June, and Fitch expects this trend to continue. Although sovereign credits remain vulnerable to “significant” pressures, the proportion of “negative” outlooks leading to a subsequent downgrade may be below the historical average.
Bonds were the most popular fund asset class amongst UK retail investors during July as dividend cuts forced equity income investors to look elsewhere for yield. The Investment Association (IA) reported net retail sales of £1.8 billion into bond funds and Global Bonds was the best-selling sector with net retail inflows of £693 million, closely followed by £ Corporate Bond with inflows of £692 million. In comparison, equity funds experienced outflows of £609 million as demand for funds in the UK Equity Income sector and the mainstream UK All Companies sector remained weak.
UK Bond Market Review
Government debt rises above £2 trillion
Government debt breached £2 trillion for the first time in July, driven higher by spending to shore up the economy. Total debt rose to £2.004 trillion by the end of July – £227.6 billion higher than at the same point in 2019 – and it is widely expected to continue its rise. According to the Office for National Statistics (ONS), this is the first time that debt has risen above 100% of GDP since the financial year ending in March 1961. The yield on the ten-year gilt rose from 0.11% to 0.31% during August.
“Governor Andrew Bailey maintained that the BoE still has enough “firepower” in its arsenal”
Credit ratings agency Standard & Poor’s (S&P) believes that the creditworthiness of UK banks will be tested as fiscal support is withdrawn. S&P anticipates an “awful earnings environment” for the sector and expects the withdrawal of Government support programmes and payment holidays to create a “credit inflexion point”. Meanwhile, the Bank of England (BoE) warned that UK businesses are facing a cash flow deficit of £200 billion; the central bank believes it is in the “collective interest” of the banking sector and the wider economy for banks to continue lending to businesses and households. However, the risk of defaults appears to be rising: the BoE highlighted emerging signs of stress and credit rating agencies have downgraded around 100 UK companies since March, although the pace of downgrades is slowing.
UK services and manufacturing companies reported a strong increase in activity during August, but IHS Markit reported that the rate of job losses accelerated amid doubts over the speed and duration of the recovery. The news compounded fears of further job losses as the Government’s job retention scheme is wound down. IHS Markit warned of “widespread concerns that the honeymoon period for growth may begin to fade through the autumn months”. The Office for Budget Responsibility (OBR) has forecast that up to 20% of furloughed workers will lose their jobs once the scheme ends.
The annualised rate of consumer price inflation rose from 0.6% in June to 1% in July as the UK economy started to reopen. Elsewhere, in a speech at this year’s virtual Jackson Hole symposium, BoE Governor Andrew Bailey maintained that the central bank still has enough “firepower” in its arsenal, despite cutting its key interest rate to an all-time low of 0.1% and expanding its quantitative easing measures.
UK Equity Market Review
UK in recession
The UK economy entered recession for the first time since 2009: having contracted by 2.2% in the first quarter of 2020, the economy shrank at a record rate of 20.4% during the second quarter. The Office for National Statistics (ONS) reported that private consumption accounted for more than 70% of the fall, and the services sector experienced its worst quarterly drop on record.
“The services sector experienced its worst quarterly drop on record”
The FTSE 100 Index rose by 1.1% in August, while the FTSE 250 Index climbed by 5.1%, boosted by a strong performance from shares in sub-prime lender Provident Financial; although the company reported a loss at its half-year results, it is expected to benefit from a surge in demand for sub-prime credit caused by the pandemic.
There was little progress in Brexit trade talks during the month, and EU Brexit negotiator Michel Barnier said that a deal “seems unlikely” as both sides failed to agree over issues including the “level playing field”, fisheries, and state aid rules. While the UK’s negotiator David Frost criticised the EU for being “unnecessarily difficult”, M. Barnier said the UK was “wasting valuable time”. The transition period ends on 31 December, and if a deal has not been approved, the UK will have to trade with the EU under World Trade Organisation (WTO) rules.
Retail sales continued to improve in July, rising for a second straight month to achieve annualised growth of 3.2%. However, the British Retail Consortium (BRC) found that footfall remained down, and warned that some retailers are “hanging by only a thread in the face of rising costs and lower sales”. The Confederation of British Industry (CBI) reported that retail employment fell at its most rapid rate since February 2009 during the year to August, and the pace of job losses is expected to increase. Looking ahead, retailers are likely to remain cautious as household incomes weaken.
The number of people in work fell at its fastest rate since mid-2009 over the three months to July, with the number of employees on payrolls down by around 730,000 compared with March 2020. The ONS reported that around 7.5 million workers were temporarily away from work in June, and the Government has come under pressure from business groups and trade unions to provide additional support or to extend its furlough scheme, which is scheduled to finish in October.
UK Equity Income Market Review
UK dividends fall sharply in Q2
UK investors suffered some of the most severe dividend cuts in the world during the second quarter, according to Janus Henderson’s Global Dividend Index, which found that dividends from UK companies fell at a headline rate of 54% during the period, surpassed only by Spain and France. On a global basis, payouts dropped 22% to US$382.2 billion, experiencing their sharpest fall since the financial crisis.
“Global payouts dropped to US$382.2 billion, experiencing their sharpest fall since the financial crisis”
Performance at global sector level was very diverse: companies in the health care and communications sectors tended to avoid having to reduce or cancel their payouts, whereas companies in the financials or discretionary consumer sectors found themselves having to make changes to their dividend policy. Performance at regional level was also mixed: dividends in North America remained almost unscathed as only one-tenth of US companies cut or cancelled their dividends, while Canadian companies increased their payouts overall.
Although over 50% of UK companies reduced or scrapped their dividends, Janus Henderson pointed out that several large UK companies have been paying an “excessively large” proportion of their profits as dividends, so the pandemic has provided them with the opportunity to “reset” investors’ expectations and implement a more sustainable dividend regime.
The FTSE 100 Index rose by 1.1% in August, while the FTSE 250 Index increased by 5.1%. Since the beginning of the year, the best-performing FTSE industry sectors were leisure goods, technology hardware & equipment, electronic & electrical equipment, and food & drug retailers. In contrast, the worst-performing sectors included automobiles & parts, oil & gas, banks, fixed-line telecoms, and travel and leisure.
BP announced a US$6.7 billion loss for the quarter and cut its dividend in half as Covid-19 curbed demand for oil. BP warned that the outlook remained “challenging and uncertain” as the pandemic continues to dampen economic activity and demand for energy for a “sustained period”. Insurer Direct Line reinstated its dividend alongside a special dividend that equalled its cancelled payout. Elsewhere, property company Hammerson announced a rights issue and expects to resume dividends in the second half of 2020.
The yield on the FTSE 100 Index dropped from 5.03% to 4.70% in August, while the FTSE 250 Index’s yield fell from 3.83% to 3.66% over the month. In comparison, the yield on the benchmark UK gilt rose from 0.11% at the end of July to 0.31% at the end of August.
US Market Review
Fed updates its inflation policy
The number of Covid-19 cases in the US rose to over six million during August, with more than 182,000 deaths recorded. Schools and colleges have been slow to reopen, and this is likely to affect consumers’ customary back-to-school purchases. Nevertheless, sentiment was boosted by hopes that a vaccine or treatment will be found, and that the economy will power through the negative impact of the virus, and share prices rose strongly in the US over the month. The Dow Jones Industrial Average Index rose by 7.6% during August, while the S&P 500 Index increased by 7% and the Nasdaq Index climbed by 9.6%. Demand for technology stocks sent the S&P 500 Index and the Nasdaq Index to new highs during the month.
“It is hard to overstate the benefits of sustaining a strong labour market” (Fed Chair Jay Powell)
The relationship between China and the US remained sour during the month as President Trump postponed a meeting with China’s representatives, saying: “You know why? I don’t want to deal with them”. Looking ahead, investors are likely to focus on the forthcoming Presidential elections.
Minutes from the Federal Open Market Committee’s (FOMC’s) July meeting showed that Federal Reserve (Fed) policymakers expect the coronavirus pandemic to continue to “weigh heavily” on economic activity, inflation and the labour market in the near term, and pose “considerable risks” to the medium-term outlook.
The Fed announced a “robust” update to its inflation policy in a move designed to give policymakers more flexibility. Instead of aiming for a fixed target of 2%, the FOMC will target an average inflation rate of 2%, allowing it to run “moderately above 2% for some time”. The change will allow the central bank to support the labour market by keeping rates lower for longer. Fed Chair Jay Powell said: “It is hard to overstate the benefits of sustaining a strong labour market”. In the longer term, however, the Fed continues to believe that inflation of 2% remains the target over time.
At this year’s virtual Jackson Hole symposium, Fed Vice Chair Richard Clarida said that Fed officials do not intend to tighten rates in response to a strengthening labour market, saying: “A low unemployment rate by itself … will not, under our new framework, be a sufficient trigger for policy action”. He also reiterated that policymakers do not regard negative interest rates as an “attractive policy option”.