Wealth Management: Strategy blog – A darker mood
Strategy team: Kevin Gardiner
Governments are edging back towards wider lockdowns: France and Germany have announced tougher measures for a month, and other governments are following suit or under pressure to do so.
The collective mood has been worsening since early September (see earlier posts) as a second wave of European contagion has gathered momentum. A distributable vaccine is not in sight, and our worries, as always, are being amplified and reflected back at us by a reliably sensational media (unsatisfied with mere pandemic, pessimistic pundits are increasingly drawing comparisons with plague). Here in the northern hemisphere the temperature is dropping and the days are shortening. Perspective is scarce again.
Global stocks tumbled on Wednesday, and further volatility would not be surprising: corporate recovery in Europe at least now seems likely to stall or even reverse for a while.
How should investors respond?
We suggest sitting tight. Short-term volatility is scary and unpredictable, but market sentiment tends to over-react (in both directions, admittedly).
There has been progress on treatment since the spring, and for the time being at least fatality rates thankfully remain significantly lower. Most European schools are still open, which helps many parents continue to work. US suppression remains lighter. We don't need a vaccine to move forwards: adaptation – a more socially-distanced world, though not a locked-down one – will do.
Market-wise, stocks had risen a long way beforehand, hitting new highs in September, reflecting a mix of anticipated economic recovery and lower expected interest rates.
We had expected economies to rebound briskly, but the bounce was more V-shaped even than we had been anticipating. Western economies have retraced more than three-fifths of the lost ground. US GDP surged by 7% (non-annualised) in the third quarter – incidentally suggesting further big gains in jobs (or a step up in productivity) ahead. Eurozone GDP surged by 13%, but from a lower base. China's economy (first in, first out) is bigger than it was beforehand (and currently facing no second wave).
Clearly, economies can still grow – when they are allowed to. Even with some slowing, in the West we might have been looking at pre-COVID levels of GDP again in 2021 (we still could be, depending on those renewed lockdowns).
At the micro level, evidence from the response to the summer's eased lockdowns, and from sustained online spending throughout, should have put paid to the idea that we are facing a new, non-materialistic world in which people will not want to travel, eat out, be entertained or indeed consume at all.
Arguably, with policy settings likely to stay generous even as economies recovered more fully – now with the official blessing of the IMF – the possibility of a period of above-trend, catch-up growth beyond 2021 was rising.
If anything, policymakers may now respond to the threat of renewed lockdowns with still more monetary and fiscal support (notwithstanding Congress's inability to agree on more US fiscal support before Tuesday's election). The ECB has just hinted at action in December. As in the spring, however, we should remember that the immediate impact will be limited: the authorities are not going to close the economy with one hand only to try to keep it open with the other.
Policy settings can help markets by supporting the economy, by making liquidity available, and by underpinning valuations. Even before long-term interest rates fell to their most recent lows, discount rates were historically subdued. When real interest rates are low, and likely to stay so, the stock market's horizons are lengthened. In this context, the loss even of a full year's earnings – which, globally, we are still very unlikely to see – would account for only a small portion (a few percentage points) of the stock market's total value.
If earnings were to dive anew, prices would fall more sharply than that, of course, as sentiment over-reacts – but if earnings eventually rebound, prices may rally again in anticipation.
This view might be criticised as a naïve "buy on dips" strategy. Naïve or not, many sophisticated pundits have been unable to come to terms with it. In fact, buying a falling market is extremely difficult, psychologically: we know it can be the right thing to do, but on the day we always find a reason for waiting a bit longer. And we may have to cast our nets widely: UK and Japanese boats have not been lifted sustainably by the global growth tide for a couple of decades now.
So again: this too shall pass. It is not a plague, we can adapt, and people still want to prosper.
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