Investment strategy in a virus-filled world

Charles Stanley’s Investment Strategy Committee met this week – here are its conclusions.

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  1. Charles Stanley

When Charles Stanley’s Investment Strategy Committee (ISC) met this week, it had a long review of the progress of the relaxation of lockdowns around the world and the likely impact on bonds and shares.

The Committee kept its recommendations on the relative attractions of asset classes and markets the same as last month. Shares and bonds are both held at neutral, with a preference for US equities and bonds. US shares are favoured owing to the strong representation of the fast-growing areas of technology in the main indices, and the substantial Federal Reserve Board and government support for markets. Treasury bonds are preferred as they still offer a positive yield at a time when Japanese and European government bonds are on negative yields – or offer very small income returns.

The Committee was very mindful of the great damage done to most economies of the world by policies adopted to curb the spread of Covid-19. The ISC expects it to take this year and next to get back to the levels of output achieved in 2019 and anticipates particular damage and shrinkage of tourism, leisure, travel, hospitality and shop based retail businesses.

Rebalance after rotation

The recent rally in shares has rotated to favour sectors that are particularly hard hit by recent events, implying an easier and quicker recovery than is likely. This offers an opportunity to reposition portfolios to reflect the new trends in businesses and economies in a world of social distancing, home working and online entertainment.

The Committee stresses that its reason for not being more pessimistic about the outlook for shares is the extraordinary monetary action being taken by most Central Banks, but especially by the Fed. The Fed intervened decisively at the point of a meltdown in bond and share markets – and has made clear it will print as much as it takes to keep asset prices up. No amount of monetary action, however, can save companies with little or no revenue. It means a period of elevated valuations of a much-diminished profit and earnings stream for many companies, with a background of cut dividends in many cases.

Over-optimistic markets?

It is a case of a growing gap between the earnings outlook for most companies in 2020 and their share prices. Markets are assuming recovery next year and are taking a relatively optimistic view of the outturn of the pandemic. Markets are not allowing for the danger of a second wave or a bad winter with more lockdowns, nor for the stresses of the badly-affected sectors infecting other parts of the economy. They are assuming that high unemployment will prove temporary, and total incomes generated will be sufficient to boost demand to decent levels.

Markets, of course, do not have opinions. We ascribe moods or views to them to help characterise and predict their movements. What all this tells us is, quite simply, there is a lot of money around particularly in the US created by the Fed. Some of this is finding its way into share buying, boosting shares despite the poor news background. This seems likely to continue for a bit, as the Fed has told us there is no limit placed on how much buying it is prepared to do in order to avoid market meltdowns.

Whilst the Fed’s attention is heavily concentrated on the debt markets, the money they spend there can find its way into shares through the accounts of the people who sell bonds back to the authorities. In the case of Japan, the central bank there is buying exchange-traded funds which own Japanese shares, reminding us that the authorities can directly seek to increase equity prices should they so wish.

Equity positions maintained

After a long debate about the bearish news and the bullish market actions, the Committee concluded that it was right to maintain equity positions even after the rally and to concentrate positions on the sectors and parts of the world that can fare best in these difficult conditions.

The Committee examined the case for switching more to recovery sectors but remained of the view that, whilst there would be large percentage increases in output from the lows of April and May, there would be no early return to previous levels – leaving these sectors well down in profit and cashflow.

There will need to be many refinancings, capital reconstructions and bankruptcies to sort out the over-investment and underperformance of the damaged areas which will be at the cost of existing shareholders. In sectors such as travel, tourism, retail shops and hospitality, it will only be the strongest companies that have a vision of how to adapt their business to more difficult conditions that can hope to do well.

The Committee noted the growing tensions between the USA and China as an important negative, with Hong Kong at the centre of the latest row. The US is threatening Hong Kong’s preferential trading status with the US and continuing to squeeze China out of 5G supply chains in the West.

It examined the €750bn EU package and concluded that as it will be spread over the seven-year budget period ahead, includes substantial loans as well as grants, and requires extra taxation at EU level it was only mildly helpful and not a major game-changer for the European recovery.

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