Rather than try and cover the six months since our last newsletter, we’ll focus on the ten week period since the interim update we issued on the 23rd March. To briefly recap, that interim update covered the Conservative win in December which boosted UK markets even though the outcome of the Brexit journey was still unclear. It explained that in February we saw world markets getting nervous about the impact of the spread of the virus in China as the local restrictions there disrupted the supply chains for many goods across the globe. It then finished on the stock market setbacks experienced in March as the virus spread internationally and governments put restrictions on the movement of populations. At the time of writing that update, the UK was not in full lockdown but this was effectively enforced by Boris’ speech on the evening of March 23.
We will again specifically comment on the investment markets (and related matters) in this newsletter but not provide commentary on the medical aspect or personal challenges faced as a result of this pandemic.
Boris’ speech on the 23rd of March also marked the lowest point (to date) for the UK stockmarket during this crisis, when the index for the largest 100 UK companies fell below 5000 points. The following six weeks saw a huge amount of daily volatility. The VIX is a market index representing volatility expectations over the coming 30 days and it ranges from 1 to 100. On March 16, this index reached 83, whilst a longer term average (i.e. representing a comfortable level) would be somewhere between 15 and 20. This index has now returned to broadly 30 and whilst volatility of this level can be unnerving it can also create a significant amount of opportunities for active fund managers.
As infection rates began to fall, societies began to make plans to reopen and a significant amount of stimulus from governments and central banks was implemented; thus volatility stabilised and the markets have continued on a positive trajectory. This last week saw the FTSE 100 manage to claw back to over 6000 points.
The rebound in the UK stockmarkets has however lagged that seen in global equity markets, which has again been driven by the US where technology stocks have soared.
Overall the UK market (measured by the largest 100 stocks) is down by 19% over the year to date whilst the US (measured by the S&P 500) is down by less than 0.5% over the same period. There has however been a huge amount of variance in the performance of different sectors; leisure, hospitality and travel have understandably been some of the hardest hit.
Of course when looking at market indices levels or share price of companies, we need to remember the other elements involved in valuing a company. The commonly used ‘Price to Earnings Ratio’ (or P/E ratio) also requires earnings and this is the element only now just unfolding as companies begin to display the impact of lockdown. This period is expected to see many companies experience large falls in earnings.
As earnings fall, this has led to the unprecedented dividend cuts and suspensions that we have seen. In our December 2019 newsletter, we commented on the competitive dividend yield payable from the UK market (around 5% per annum) but we explained that this was unlikely to continue given the global slow down and uncertainty surrounding Brexit.
We stated that even if there was a 14% drop in this yield (as seen in the Global Financial Crisis), this would still remain competitive.
There is now a very real possibility that UK dividends will fall by a third. Most notably we’ve seen Royal Dutch Shell cut its dividend for the first time in seventy years and a severe cut at that, to a third of its previous level. This is because the oil price has plummeted at the same time as the crisis. This is of course disappointing for income investors but a necessary move for companies to focus on their long term business viability rather than paying a dividend in the short term. It is also worth noting that the dividend changes are very varied across different sectors and we are optimistic that the collective fund managers used in our clients’ portfolios give a good spread across the sectors where income is a focus.
The short term economic data is likely get worse as the contraction of the GDP really takes hold and this statistic is expected to be much worse (over this short period) than during the financial crisis. It is also sensible to assume that this will be worse for consumer driven economies, like the UK, and whilst the immense amount of stimulus provided by the government has gone and will continue to go some way to support the economy, this clearly will need to be repaid at a later date. It can only last for so long.
So whilst it is positive that markets have recovered some ground, the uncertainty continues and the shape of the recovery from this pandemic very much depends on the extent to which societies can successfully reopen.
Some economists are looking to China for an indication of how the recovery might evolve. They have had a ‘V’ shaped recovery in manufacturing, infrastructure and construction, and it is only their new export orders that are much slower as the rest of the world is now in mid crisis. China has also managed to avoid too much economic disruption from a second wave of the virus as restrictions were lifted.
We could look to compare this with patterns of previous downturns including that of 1974 where UK equities experienced the largest drop on record over one year of -50.4%. But in 1975 the market had the best ever year with a return of 145.2%.
This short lived recovery was also true (albeit not on the same scale) for 1991, 2003 and 2009. We cannot use this as a prediction but it does illustrate that a bear market (or decreasing market) has historically been relatively brief. In fact, on average a ‘bear ‘market is 1.3 years long and therefore we continue to encourage investors to take a long term view. There are however lots of factors that make the current unprecedented situation feel different as we really are in unchartered territory.
Added to all this, we have more cracks appearing in the US – China relationship with both sides publicly criticising the other for how they have dealt with the pandemic. President Trump has one eye on the election later this year and the head to head with democrat candidate, (former vice president) Joe Biden, can already be seen in Trump’s reaction to the pandemic, in Chinese relations and in the surge in US unemployment to 39 million.
In summary we expect the volatility to continue in spates over the short term but this has always been part of the journey for long term investments and as commented in our interim update, at times like these, we believe it is best to avoid knee jerk reactions and we encourage our clients to focus on the long term.
Most importantly, we hope that you and your family are keeping safe and well in the challenging environment we are all experiencing.
The Michael Ambrose Group has had to adapt the way we operate but we are confident that we can maintain our high standards of service to you. We appreciate this exceptional period also means that you might want to communicate more frequently with us about your investments so please do get in touch with your usual adviser if you wish to discuss matters. We have now reopened our office phone line.
The purpose of this newsletter is to provide a commentary for general interest purposes. It is not intended to provide recommendations, or to provide a deep technical analysis. If you would like more detailed information, or have any questions regarding your individual portfolio, then please speak to your usual adviser. Thank you.