While the third quarter of the year was marked by a continuing rebound in the economy and markets, there was also a barrage of negative data as company results and economic figures for the second quarter were released. Although, the impact of the lockdowns on companies was more varied, as expected. Those forced to shut or severely scale back operations posted large losses, although many have also shown extraordinary flexibility and dampened the negative effects. Conversely, some companies have benefitted from a forced change in behaviour, such as online retail and technology.
The world now appears to be in a much better situation to deal with the implication of COVID, with massively scaled up testing programmes, improved treatment techniques and an additional three months of research into vaccines, which show promise. While the theory is yet to be tested, these should mean that large areas or countries should be able to avoid crude lockdowns.
Although COVID is very much present, investors have continued to back equities higher. However, the rise has been driven by a narrow set of companies, mainly US listed and mainly technology focussed. Given the dominance of these companies in US and global indices, these have led markets to new highs. While earnings expectations for 2021 have improved slightly over the last several months, most of the rise has been driven by multiple expansion, making equities look expensive by traditional measures. Towards the end of the third quarter, there has been a growing appreciation of the high valuations of these companies and/or profit taking that has seen this area of the market underperform other areas. It is still too early to say whether this is part of a longer-term trend or a correction on the way higher. Nevertheless, the high valuations of these companies make high medium term returns doubtful.
The main political event of the coming quarter is the US presidential election in November. As usual, there has been a long build up to this. Currently Biden has a comfortable lead in the polls, however, as we have learned over the last several years, this is no guarantee. While there are clear policy differences and leadership styles, the outcome of the election may not be significant to markets. Nevertheless, expect volatility as the vote approaches.
The world has an increasing number of localised outbreaks at different stages, making aggregated data less useful. New outbreaks in India and further spread in Latin America (as well as increased testing) means that global cases continue to grow, although the figure does appear to be plateauing. The greatest areas of concern for markets are the drawn-out impact of the infection in the US, and the multiple second waves now appearing in Europe. The emergence of second waves illustrates to markets that this is an issue that can linger for some time. While it does not mean that entire economies will be shut down once more, it does suggest that there will be ongoing disruption and uncertainty for companies and individuals. Certain sectors are likely to be impacted far more than others in such an environment.
Politicians and the population appear to be more willing now to accept some potential healthcare issues as a fair trade for reopening the economy and schools. New measures and policies are more nuanced, and policymakers are keen to ensure that the economic considerations are incorporated, something that was not as clear during the first stage of the pandemic.
While we are unable to predict the pathway of this virus and the likely policy responses, we are cognisant that this remains a significant risk to equity markets and risk assets more broadly.