Friday, 23rd of October 2020
“The darkest hour is just before the dawn”
– Thomas Fuller
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Markets traded sideways this week as European countries in particular lined up to impose fresh curfews, lockdowns and other draconian restrictions on an increasingly weary local population. As we enter the final months of 2020, a perilous new wave of the coronavirus in Europe, and its ongoing spread in the US and parts of Asia, threatens to halt the tentative global recovery that began over the summer. Winter is coming – and a chill wind has begun to blow. This week so far, the S&P 500 Index has dipped -0.9% and the Euro STOXX 600 Index is down -1.2% in turn. That these benchmarks have not fallen further (particularly the latter, as cases of infection spiral upwards) is testament to the enormous power of the QE programmes launched by the Fed and ECB as well as the unprecedented fiscal response on both sides of the Atlantic. Copious liquidity has helped to stabilise markets since March, as well as parts of the economy that are less exposed to covid-19. However, stressed sectors and firms in the hospitality, retail, and travel industries face huge pressure from ongoing social distancing restrictions, and they are burning through what remains of their cash reserves at a truly ferocious pace. When the time comes to refinance their heavily depleted capital structures, and with an uncertain (and increasingly bleak) future ahead, many will struggle to convince past creditors that they remain going concerns. A wave of defaults is sure to follow; indeed, in many countries this wave is already breaking. Investors may still be drunk on stimulus dollars for now, but they can’t ignore corporate fundamentals for ever. As we enter Q3 earnings season, and with the bitter US presidential election just days away, investors may soon find that they have been walking on air. We are therefore more than happy to keep our portfolio protections in place for now; and we won’t be adding traditional credit risk until spreads reflect the new reality.
But among the dark clouds that have gathered on the horizon, one splinter of sunshine is the prospect of an increasingly imminent US fiscal stimulus. Congressional Democrats and Republicans have been sparring over the size of the fiscal package since the summer – and an impatient Fed has broken with convention to voice public frustration at the lack of action. Both parties agree that the impulse must be large, but the Democrats are pushing for an eye-watering USD 2.2tn in additional government spending (and the House passed a bill to this effect on 1 October). The Donald is impatient to get a deal across the line before the election so he can claim credit, and Americans can see a wall of green figures when they check their Robinhood trading accounts on their way to the polls. But time is running short. There are now less than two weeks until voters can have their say on the first four years of America First. It is not clear why House Democrats would agree to anything short of total victory in these circumstances, and Treasury Secretary Mnuchin seems to be under orders to give it to them. He has offered a string of concessions in recent days, and fiscal conservatives in the Senate have baulked at the prospect of a budget busting spending splurge on Pelosi’s terms. Whether the Donald can bully them into accepting something close to the USD 2tn package now being floated remains to be seen. We suspect that there will not be an agreement before the election, but that one will come soon after when the politics recedes, and the economics comes back into view. The US is in much better shape than Europe, where the flash PMIs for October suggest that the Eurozone has returned to recession this month and a McKinsey study suggests that two-thirds of SMEs fear for their very survival over the next year. But even Uncle Sam will need help to get back on his feet after such a bad bout of covid-19.
Another negotiation where events seem to be moving quickly is on the small matter of Brexit. At the end of last week, PM Johnson finally called off trade talks with the EU and told the UK to prepare for a ‘no deal’ exit at the end of the year. Nevertheless, he also suggested that the door was not completely shut to talks if EU negotiators took a fundamentally different approach in future. After some back and forth it looks like something was said (beyond the public platitudes about concessions on both sides) because Barnier has come to London and the chattering classes are doing just that. We believe that a deal will eventually be struck, and that sterling is likely to pop on the news. However, we remain cautious about the downside risk of a possible ‘no deal’ Brexit and we are negative on the UK economy, which has performed poorly through the current crisis. Once the initial bounce has been logged, the currency may then begin to slide as investors focus on issues other than Brexit developments. As such, while we have a more positive near-term view on the pound, we remain negative when looking beyond this year.
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