October was a challenging month for markets. The increases in COVID-19 cases in Europe and the US weighed heavily on their equity markets towards the end of the month, with falls accelerated by announcements of new lockdown restrictions in countries across Europe. Political uncertainty was also at the forefront of investors’ minds, with October being the last month of political lobbying ahead of the US election on 3 November and further Brexit negotiation posturing by both UK and EU.
November was a stellar month for markets as three different vaccine trials reported successful phase III COVID-19 results on three consecutive Mondays. This provided a much-needed boost to equities, particularly more cyclical companies and those hardest hit by the impact of Coronavirus. The result of this was a significant rotation towards cheaper ‘value’ stocks and away from more expensive ‘growth’ stocks. Markets had already been edging up after it became clear Joe Biden had won the US presidential election, although President Trump disputed the outcome and unsuccessfully tried to overturn the results in the courts claiming voter fraud. Brexit remained a risk for UK investors with no tangible progress during the month on a deal.
December was another strong month for markets with the first western vaccine approval and vaccination taking place in the UK, with other countries following during the rest of the month. Market optimism sat at odds with further increases in both Coronavirus cases and deaths across the globe as well as the reintroduction of further restrictions on social mixing throughout Europe. The US finally approved another pandemic relief plan, and a Brexit deal was finally passed on Christmas eve (the 1,250 page agreement document providing some light festive reading!).
The fourth quarter as a whole was extremely strong for risk assets as vaccines provided a light at the end of the tunnel for COVID hit economies. Market volatility (as measured by the VIX index) receded and global developed equities (measured by the MSCI World Index) rose almost 8% in sterling terms. The FTSE 100 rose a remarkable 10.9% including dividends (although it still lagged other asset classes for the full year) and emerging market equities were up 13.2%. Commodities also rallied, with oil up a remarkable 26.5%, although gold was up only a modest 0.7%. Defensive bonds (as measured by the Bloomberg Barclays Global Aggregate which consists mostly of government bonds) rose 0.8% over Q4 whilst riskier high yield bonds were up 6.6%.
Data source: Financial Express
Indices used (including interest & dividends): Defensive Investment Grade Bonds - GBP hedged Bloomberg Barclays Global High Yield Index; Riskier Bonds (High Yield) - GBP hedged Bloomberg Barclays Global High Yield Index, Developed World Equities - MSCI World Index in GBP; Emerging Market Equities - MSCI Emerging Markets Index in GBP; FTSE 100 (UK Large Capitalisation Equities)
Diving into performance within indices, it was the securities of smaller companies that outperformed, up over 17% for the quarter. Cheaper securities (‘value’ companies), also rose strongly, up 9.5% whilst ‘high price’ securities (often described as ‘growth’/’momentum’/’quality’ companies) slightly more modestly, albeit still strongly at +6.4%.
Data source: Financial Express
Indices used (including interest & dividends): Developed World Equities - MSCI World Index in GBP; Growth Equities – MSCI The World Growth Index; Value Equities – MSCI World Value Index; Small Company Equities – MSCI World Small Cap Index
2020 was quite a year, capped off by an extremely positive fourth quarter as the three main risks visible to markets receded. Positive vaccine trial data and the start of the roll-out of the injections promised an eventual end to the COVID-19 pandemic. The US elected Joe Biden and, despite Donald Trump’s best efforts, a political meltdown over an inconclusive result was avoided. And a Brexit UK-EU trade deal was, finally, concluded.
Brexit and US politics have thus receded as sources of acute market risk (although they are by no means completely settled). Coronavirus is, unfortunately, still very much with us and is still the most obvious source of portfolio risk as we head further into 2021. The other main source of risk at present is the extreme optimism being shown in certain parts of the market, an optimism that might well reverse for other reasons.
Looking first at the pandemic, we are in the midst of a very serious second coronavirus wave. This has been exacerbated in the northern hemisphere by winter but also by the emergence of more virulent mutations of the virus, notably those in the UK and South Africa and has necessitated further partial and full lockdowns. At present, vaccines still appear to be effective against all known variants of the virus, but any problems with the vaccine roll-out, or further mutations that increase resistance to the current crop of vaccines would likely delay the re-opening of economies and be very serious for both public health and for markets.
That said, markets are either at or close to all-time highs, so they are clearly betting on the success of the vaccines. And provided there are no serious hiccups, there are indeed many reasons for optimism. The new Biden presidency, the Democrats’ continued control of the House of Representatives, coupled with their recent victories in Georgia which give them narrow control of the Senate, mean that the Democrats should be able to push through significant fiscal stimulus in the form of direct transfers to US citizens as well as key infrastructure spending. This should help fuel a US recovery and, with luck, help temper the populist anger simmering throughout the country.
Elsewhere in the world, central banks have kept interest rates at rock-bottom levels whilst continuing to buy huge amounts of government debt, meaning that governments can continue to cheaply borrow to prop up their economies and invest for the future. It is true that government debt has increased markedly (see below), but that matters less for countries than the total cost of servicing their debt. This continues to fall because bond yields have fallen so much in response to the virus and central bank action. Put another way: the total amount of government debt may be going up, but the rates paid on issued debt has fallen much more, resulting in the total interest paid by governments in $, £ or € actually decreasing as older bonds paying a high coupon mature to be replaced by new bonds paying very low coupons.
In addition, whilst the UK/EU Brexit trade deal is already experience teething issues as new trade frictions have emerged between the two trading partners, the removal of the possibility of a no-deal scenario should lower uncertainty in the UK and help support the value of UK assets and increase inward investment.
The UK is, as a result of being out of favour for a long time largely because of Brexit uncertainty, one of the cheapest markets at present, both in an absolute sense but also relative to other markets and its own history. Japan and Emerging Markets also look reasonable value.
Source: J. P. Morgan Asset Management Guide to the Markets Q1 2021
Other markets are more expensive with US equities arguably the most richly valued. The below chart looks at Warren Buffet’s preferred measure of stock market valuation, the S&P 500’s market capitalisation against the value of US GDP which is at record highs. The S&P 500, despite consisting of companies listed in the US receives a great deal of its revenue from outside the US, so arguably it makes more sense to compare the index against global GDP – but even here US equities are at levels not seen since the tech boom of 1999/2000.
In an extremely strong quarter for performance overall, developed Pacific ex-Japan equities were the strongest performer, up 13.6% followed closely by EM equities and UK equities. US equities were the strongest performing asset class over the year. Global listed Infrastructure was the worst performing asset class over the quarter, up only 2.8% but it was commodities that suffered most over the year, dragged down by oil.
Riskier bonds continued to perform well in Q4, with global high yield bonds leading the pack. Inflation linked bonds were, however, the best performing fixed income asset class over the year. Click here to view the Investment Commentary from Q4 in 2017.
Data source: Financial Express
Indices used: 3m GBP LIBOR, GBP hedged version of FTSE World Government Bond Index, GBP hedged version of FTSE WorldBIG Corporate Index, GBP hedged Bloomberg Barclays Global High Yield Index, GBP hedged version of FTSE Global Emerging Markets US Dollar Government Bond Index, MSCI North American Index, MSCI Europe ex-UK Index, FTSE All Share Index, MSCI Japan Index, MSCI Pacific ex-Japan Index, MSCI EM Index, FTSE Global Core Infrastructure 50/50 Index, FTSE EPRA NAREIT Global Index and S&P Goldman Sachs Commodity Index
Data Source: PortfolioMetrix, Bloomberg
*Glossary of Financial Terms
Quarterly vs annualised growth rates: Some national statistical agencies prefer to quote country growth levels in a quarter as an actual quarterly rate (the estimate of growth over three months, x, sometimes referred to as “on quarter” growth) whilst others prefer to quote the growth over the quarter on an annualised basis (i.e. assume the growth over three months continued for a year, 4x). We tried to quote only an annualised rate above using the following approximate relationship: annualised rate = 4 x quarterly rate.
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