March 23rd 2020 is likely to go down as an historic day for the UK’s citizens, and for those among them with an interest in the stock market. That day saw Prime Minister Johnson’s announce that we must all stay at home where possible. It also marked the low point in the UK stock market’s response to the global spread of the coronavirus. Incredibly, more than fifty days have since passed. While, reassuringly, there has been no descent into the sort of post-apocalyptic social disorder portrayed in many a disaster movie, much has undoubtedly changed. As investors, our job is to understand these changes, to differentiate between temporary disruption and more lasting effects, and to respond accordingly.
That the UK stock market troughed on the day the UK entered lockdown may appear coincidental, or perhaps even counterintuitive. However, it is in many ways illustrative of the forward-looking nature of financial markets. As the virus spread around the globe, investors struggled to estimate its potential impact on the economies and companies in which their portfolios were invested. Once the nature of the policy response (effectively a voluntary but temporary economic shutdown, offset by unprecedented support from governments and central banks) became clear, expectations could be grounded on some sort of reality. Seen in this light, it is perhaps unsurprising that the uncertainties engendered by the relaxation of lockdown measures in many regions have recently prompted some jitters in global financial markets.
At the core of these uncertainties lie concerns that, eager to reignite their economies and conscious of the political costs of being perceived as laggards, some authorities may prove too hasty in relaxing the measures taken to control the virus. Lockdown has largely worked as intended, limiting contagion and reducing the human cost of the pandemic. If relaxed too early, there is a risk that these hard-won gains are sacrificed. Having entered lockdown later than many other nations, the UK and US appear among the most susceptible to this risk.
It is also becoming clear that the much-hoped for ‘return to normality’ will be a lengthy process. The majority of governments have adopted phased strategies for ending lockdown, prioritising the resumption of activity in some industries while pushing back the re-opening of others. It is clear that the recovery will not be uniformly enjoyed by all sectors of the economy. This is particularly the case where the pandemic may have encouraged behavioural shifts that may be slow to fade, for example the willingness of individuals to attend large social gatherings such as concerts or sporting events.
While lockdown measures have been key to managing the pandemic from a medical perspective, the enormous stimulus unleashed by governments and central banks have been paramount from an economic point of view. Government expenditure has rocketed and interest rates have been slashed in an attempt to support economies, companies and workers through the sharp recession that has been the inevitable price of the lockdown.
In the UK and Europe, government policy has encouraged companies to retain their employees by subsidising wages. Importantly, the retention of a skilled and experienced workforce should allow companies to quickly resume production once conditions allow. In contrast, with its more flexible labour market, the US has been willing to accept a huge increase in unemployment in the expectation that it, and the associated costs of enhanced social benefits, will prove temporary. Though differing in implementation, both approaches are intended to channel money to consumers, providing demand to meet potential supply.
From an economic perspective, thanks in part to the speed and scale of the policy response, the current recession is unique. While most recessions are tougher for the manufacturing sector than for service providers, here the reverse is true. This distinction may seem unimportant, but it arguably holds the key for expectations of a swift economic recovery. As we have seen in China, whereas a typical recession normally involves the permanent destruction of capital, this has not yet occurred: machines that have lain idle for a matter of weeks can easily be switched back on, and manufacturing output can quickly rebound.
However, there must be demand for that output. Government efforts to support consumers are therefore crucial. Though a great deal has already been done (for example the extension of the UK’s furlough scheme through to October), we expect further action in due course.
As we have previously noted, though reasons for optimism remain, the road to recovery will not be smooth (see ‘A Bumpy Road Can Still Lead Somewhere’). Unfortunately for investors, the bumps are likely to be amplified in financial markets (see ‘Further Gains for Global Stock Markets’). Indeed, the FTSE All Share index of UK stocks has dropped c.6% on two separate occasions over the past few weeks. Nonetheless, at the time of writing, it is broadly unchanged since mid-April (see Figure 1).
Figure 1: FTSE All Share index of UK stocks, year-to-date
Source: Bloomberg, 31st December 2019 to 12:00 on 15th May 2020
We continue to believe that the world economy and its financial markets will recover from the exceptional challenges posed by the coronavirus. However, where we have the necessary flexibility, we have sought to benefit from the exaggerated ups and downs of global stock markets. Having added to equity allocations in OMPS portfolios through March’s sell-off we have since taken profits, selling equities in late April and at the start of this week and reducing our participation in the two falls noted above.
Following these trades, we are neutrally positioned in equities across the OMPS portfolios. This positioning strikes a balance between expectations of a meaningful – though likely still partial – economic recovery as social restrictions are eased and the risk that markets react badly to the hurdles we will inevitably encounter along the way. Investors in the service should expect us to continue to respond actively to developments either in the economic outlook or in the valuation of financial assets that cause this balance to tilt.
Deputy Chief Investment Officer
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This update reflects Omnis’ view at the time of writing and is subject to change.
The document is for informational purposes only and is not investment advice. We recommend you discuss any investment decisions with your Openwork financial adviser. Omnis is unable to provide investment advice. Every effort is made to ensure the accuracy of the information but no assurance or warranties are given.