The US Election held at the start of November resulted in what was preceding flagged as the worst potential outcome for the markets, a narrow Biden win. The reasoning was that any potential stimulus would be watered down as compromises would be needed to get it through split Congress, and a narrow victory would leave him more open to a legal challenge from the Trump campaign. Indeed, it appears that both of these have happened. However, this did not limit the markets from reacting positively following election day. It seems that a significant amount of cash has been waiting on the side lines waiting for clarity over the result before being invested and in hindsight, the most outcome would have been satisfactory.
While there are continuing legal challenges to the result, the validation by the electoral college in December means that Biden will very likely enter the White House in 2021.
Brexit negotiations dragged on with many deadlines broken and pushed back. Although slow, the main sticking points were being solved (fisheries, level playing field, arbitration). As usual, developments were most cleanly displayed through the impact on the Pound. Using just the dollar in this instance does not illustrate the success of these developments as the majority of this move over the quarter was as a result of the weak dollar, rather than a strengthening pound. Against the Euro, the Sterling has been mostly stable.
Foreign Exchange Movements
Currency movements have been less severe over the last quarter. Sterling did grind higher, although increasing uncertainty over the outcome of the trade negotiations with the EU did lead to some higher volatility during December. The dollar has weakened further as investors became more bullish on the global economy. There continues to be longer-term structural reasons for a weaker dollar having been relatively strong for a number of years. A weaker dollar has the most prominent impact on the Sterling returns of US equity investments, which are more than typically dependent on domestic earnings, meaning a weaker dollar will be a headwind.
A weak dollar has also historically had a positive effect on emerging market returns. While the prominence of dollar borrowing is not as widespread as it was, a weak dollar should still provide a positive impetus.
While objectively the global coronavirus outbreak became significantly worse in the quarter the vaccine news allowed investors to look through the increasing rates of infection and government lockdown. The outlook for next year, particularly the first half, has been meaningful improved. As the vaccine is deployed to those most at risk of infection and hospitalisation first, the danger for the virus should quickly diminish and allow activity to return to normal much more quickly than previously anticipated.
The benefit from a vaccine will be most rapid in the US and Europe (including the UK), as the cost of the first vaccines is high and Western governments have pre-ordered in bulk. Nevertheless, with four or more viable vaccines likely, some of which will be more accessible to poorer countries, it is reasonable to anticipate that most areas of the world will have vaccination programmes in place by the need of 2021.
The current situation remains precarious, as cases in Europe and the US are peaking once again and there are signs of a second wave in a number of other regions (eg Brazil). The more infections variant in the UK also poses a significant risk in the shorter term and it is unlikely that this will spread globally. As the testing regimes have dramatically improved over the course of the year assessing development using case data remains unproductive. However, with the rate of weather significantly surpassing the April peak, the virus clearly remains widespread, particularly when considering the treatments have also improved.
The positive view is that as this current wave is overcome, the impact of the vaccine rollout will begin to take effect, lessening the need for the most restrictive measures to be in place.
The discovery of a new COVID strain that is more transmissible than previous variants has caused increasing concern in recent weeks. While the strain was first discovered in the UK, it may well have originated elsewhere and could already be established globally. While there is not any current concern over increases in the case mortality rate or effectiveness of a vaccine, the prospect of a more rapidly spreading virus does pose other problems. The peaks of infection are expected to be higher and outbreaks will occur more quickly, making changes in government policy harder to anticipate. At this stage very little is known on the impact of this new strain, however, it presents a significant negative risk.
Following the initial rebound in growth rates, economies slowed in Q3/Q4 as restrictions remained and many unable to bounce back to full capacity. Manufacturing and construction have now broadly rebounded, and the biggest drag continues to be the most severely impacted area, services. Resultingly, those countries (such as the UK) that are most reliant on the services sector have seen the largest drawdown in GDP and the weakest rebound so far.
The manufacturing PMI chart below illustrates the speed of the recovery as factories have been able to restart much more rapidly and the demand for goods has been robust. There is likely to be a period of restocking after inventories were run down through the shutdowns in H1. This will lead to the economy, and particularly the manufacturing sector running hot to meet increased demand for consumers reallocating spending to good and undersupplied businesses. some tension has already been seen in the system with port capacity under stress, leading to increased costs and transport times. This has already resulted in higher transport costs and could feed through into high inflation in the shorter term as these issues work their way through.
See below the US unemployment monitor, the official rate of unemployment is now 7.7% (November 2020) down from 14% in April. Furthermore, there has been a marked recovery in US employment over the quarter, have reached a low in April/May. Total employment in the US is now 12% higher than it was in April, although this is from a low base and is still 5% down from the peak. There is still a shortfall of 4m in the total labour market, implying that inactivity is also an issue. Some have suggested that the ending of furlough and unemployment allowances will lead this to unwind but effects such as early retirees etc. might be more persistent.
There continues to be a high level in initial jobless claims, suggesting that businesses are still laying off staff, even if this may be more compensated for with rehiring. The second wave of COVID cases in the US also appears to have led to an increasing level of layoffs over the last several weeks.
There is significant evidence that demand for borrowing is robust, particularly for home purchases. This has been supported in the UK by the reduction in Stamp Duty. However, the rise in average prices has already exceeded the saving in stamp duty and the rush of finance means that bank operations have been put under strain. This has led to mortgage spreads widening, particularly for high loan to value rates. While it is expected that the stamp duty holiday will end and take some of the wind out of the market, this is also likely to lead to a slow retracement of spreads, perhaps providing a further impetus for borrowers as their interest costs decline.