Friday, 18th of September 2020
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
– Benjamin Graham
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Markets have been very mixed this week with participants unsure of how to interpret a confusing concoction of economic data, minor shifts in Central Bank language, and conflicting reports on vaccine progress. Heading into Friday, major equity indices have made few moves of note and remained mostly flat for the week. Looking beneath the bonnet, we have seen dispersion between sectors and a continuation of the rotation out of large cap tech into more cyclical/value-oriented parts of the market that began at the start of September. While the S&P 500 was up ~50bps for the week at Thursday’s close, the Communications Services sector (over 50% of which is made up of Facebook, Alphabet, and Netflix) is on track for its third consecutive weekly decline and is down -6.5% for the month. On the other hand, the Industrials, Materials, and Energy sectors are all up. These moves are a clear indication that scepticism over the lofty valuations in certain parts of the equity market, particularly the technology sector, have not been completely shaken out by moves in previous weeks. That said, we also saw the largest software IPO ever on Tuesday when Snowflake, a cloud data warehousing firm, closed on a valuation of $70bn. This represents ~140x its current annualised revenues and 6x the valuation earned at a private fund-raising round earlier on in the year, while the company also posted a $171mn loss in the first 6 months of 2020. What’s not to like? This does highlight that there is still plenty of cash to be thrown at the next hot thing and we expect that many see the recent drawdowns, as well as future ones, as opportunities to “buy-the-dip”. This will likely limit the scale of any corrections. However, a host of major geopolitical risks still threaten the outlook and we remain wary of a big move before year-end. Our hedges remain firmly in place.
Central Banks have certainly had a busy week as the Fed, Bank of England, and Bank of Japan all held meetings, but there was limited action (and no major surprises) on the policy front. The Fed simply reiterated their commitment to keeping interest rates where they are for the foreseeable future, though they also highlighted that they expect a slow economic recovery that would require further fiscal support to sustain it. Their outlook was supported by marginally weak US data, with jobless claims falling but remaining elevated at 860k and a slowdown in the recovery of the Philadelphia Fed’s Manufacturing Index. They stated that they will keep rates low until inflation “is on track to moderately exceed 2% for some time”, an explicit commitment to the average inflation targeting regime discussed in August. Most notably, the Fed’s dot plot showed that all bar one member (of 17) voted to keep interest rates at their current near zero-levels through until the end of 2022, while only four thought that rates should rise in 2023. Even with what amounts to a 3-year commitment to near-zero interest rates, markets still managed to take umbrage at the Fed’s decision not to expand their bond purchase programme and equities fell following the announcement. This is certainly symptomatic of the current market, which appears to be entirely dependent on an ocean of liquidity supplied by central banks (and governments). While we don’t expect this liquidity to evaporate any time soon, it is hard to be comfortable when asset prices are standing on only one leg. The Bank of England also made no changes to its policy settings at their overnight meeting – the cash rate will remain at 0.1% and its asset purchase programme will remain at £745bn. However, the minutes highlighted that consideration was given to negative interest rates as a policy tool in the event that the economic recovery falters. The MPC was briefed on the possible implementation of a negative interest rate policy, while also planning to consult with the banking regulator over operational aspects of such a policy. Markets are now having to seriously consider the possibility of negative rates in the UK, particularly with a murky economic outlook as the controversial Internal Market Bill continues to pose an additional challenge to trade negotiations with the EU while concerns over a second wave of infections and the subsequent movement restrictions gather momentum. UK interest rate markets priced in a -20bps rate cut by the end of 2021, implying an expected cash rate of -0.1%. The pound initially fell on the news but remains up against the USD (+1.5%) for the week due to strong retail sales (2.8% YoY and 4% above February levels) and better-than-expected unemployment claimants (73.7k vs 100k expected).
Elsewhere, progress on a vaccine remains at the forefront of everyone’s mind, particularly with global cases hitting 30 million this week and a spike of infections in Europe. However, the timeline for this remains under contention. In the US, the director of the Centers for Disease Control and Prevention told a Senate subcommittee this week that most Americans are unlikely to be vaccinated until well into 2021 due to production and distribution challenges, even if a vaccine is FDA approved by November/December. This did not chime well with the Donald in his capacity as the White House’s immunology expert, who claimed that Dr. Redfield – the director mentioned above – “made a mistake” and was “confused”. Indeed, Trump said that he expects to a vaccine to be approved by October (conveniently just before the election), with one of his advisors claiming 700 million doses could be available by the end of Q1. Unfortunately for Trump, and the rest of us in this case, the approval and subsequent distribution of an effective vaccine is dependent upon the results of clinical trials rather than the whims of a man with no relevant qualifications and dubious incentives. With that in mind, three promising candidates (produced by Moderna, University of Oxford/Astrazeneca, and Pfizer) are currently being accelerated by “Operation Warp Speed” through phase 3 clinical trials, with approval by the FDA possible within the next few months if the interim results look overwhelmingly positive. The world is watching.
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