20 Nov 2020
Hugh Gimber, Max McKechnie
As the northern hemisphere headed firmly into autumn, the October news flow was dominated by two topics: the resurgence of Covid-19 in Europe, and the upcoming US elections. Markets spent much of the month in wait-and-see mode, before the announcement of widespread restrictions across Europe in the final days of the month tipped the balance of risks to the downside.
Europe is unfortunately suffering a second wave of coronavirus infections with all major economies now reporting new highs in infection rates. The policy response was originally much more targeted than that seen in the spring, with governments imposing local restrictions in a bid to avoid national lockdowns. Sadly this approach appears to have had limited success with a number of countries now re-imposing national level restrictions. Against this backdrop, highfrequency measures of European activity have started to move lower as containment measures take hold. Survey data have also highlighted a bifurcation between the manufacturing sector, which has continued to recover, and service sectors, which are once again subject to restrictions. This will bear watching to see if the trend continues as lockdowns tighten.
The perennial issue of Brexit also re-emerged last month, with the European Council meeting on 15-16 October (which was previously seen as a key deadline) passing without a deal being struck. After negotiations were briefly paused, talks are now intensifying as both sides seek to agree a trade deal before the year end.
In the US, while the virus has remained prevalent the news flow has focused primarily on the upcoming elections. Over the month the Democratic nominee Joe Biden extended his lead in the national polls and ended October eight points ahead, as well as holding his lead in a number of the key swing states. Markets responded positively to polls indicating an increased likelihood of a Democratic sweep of the House, Senate and the presidency against a backdrop of continued gridlock in Washington on a new fiscal package. The pandemic has changed the market’s focus this year. While earlier in the summer the potential for tax hikes under a Democrat sweep were viewed with some caution, a clear-cut outcome that unlocks fiscal stimulus in the near term is now viewed as the most pressing issue.
Positive gains in US and European stocks over the first few weeks of October were erased in the last week of the month, as market volatility spiked in reaction to new lockdowns. The S&P 500 ended October down -2.7%, while Europe ex-UK stocks were the biggest laggard, down -5.4%. Asia was the regional winner, with strong Chinese data helping emerging market stocks to return 2.1% over the month. In fixed income, US 10-year Treasury yields rose by 18 basis points, while European virus concerns pushed 10-year German Bund yields 10 basis points lower. Corporate bonds were broadly flat, with returns of -0.1% for global investment grade credit.
Exhibit 1: Asset class and style returns
US daily coronavirus cases increased throughout October to 81,000 per day. The mid-west is now bearing the brunt of the new infections. Hospitalisations and ICU utilisation are both rising and while there is currently still spare capacity there is now cause for concern that current activity levels will place too great a burden on the system over the winter months. The increase in cases has not so far impeded the reopening of the US economy, with 29 states now fully reopen. That said, while activity data in the five most populous states has increased slightly over the month, it is still 30% below last year’s level. The weakening in growth momentum has also been reflected in more traditional economic indicators, with services and manufacturing purchasing managers’ index (PMI) surveys for October both printing below September levels at 54.6 and 53.4 respectively.
Risk assets generally reacted favourably to polls pointing to a higher likelihood of a Democrat clean sweep in early October. With negotiations between House Democrats and Senate Republicans on a new fiscal stimulus package at an impasse, markets appear to view the prospect of near-term stimulus that could be unlocked by a “blue wave” as outweighing the potential headwinds from tax rises further down the road. Strong gains for the S&P 500 early in the month were subsequently given up as renewed concerns around the pandemic took hold. US stocks returned -2.7% in October, with mid- and small-caps outperforming larger counterparts.
Exhibit 2: Fixed income sector returns
By the end of the month, all the major economies in the region were recording record daily cases per million citizens. Policymakers sought to balance economics with virus control and initially adopted a series of local lockdowns. Yet, as the month progressed, several major governments including Spain, France, Germany and Italy were forced to adopt national level restrictions. The Spanish government’s decision to extend its furlough scheme now means that all of the major economies in the euro area will benefit from ongoing labour market support. Yet this has not been enough to prevent a deterioration in the consumer outlook: the increase in infections and restrictions has impacted sentiment with consumer confidence falling. Equally of concern is the increase in the eurozone unemployment rate, which rose to 8.3%.
European equities delivered negative returns of -5.4% over the month underperforming most major regions. Germany was the biggest laggard, giving back some of the outperformance witnessed over the summer. This same cautiousness translated to fixed income assets, with 10-year German sovereign debt yields moving 10 basis points lower to end the month at -0.63%, while European credit eked out modest positive returns.
Exhibit 3: World stock market returns
The UK also saw a significant increase in Covid-19 infections in October. In England, a tiered system of restrictions was initially rolled out before a persistent rise in new cases led to national lockdown measures being announced on the final day of the month. Restrictions varied across the different nations but the direction of travel towards tighter controls was consistent. After much back and forth, the UK’s furlough scheme will now be extended, having previously been due to end on 31 October. With 9% of the UK workforce still on furlough in October prior to new lockdowns being implemented, it is clear that additional fiscal support was required.
The second key issue driving UK markets is Brexit. Posturing aimed at domestic audiences slowed progress in October, with the European Union (EU) beginning legal action against the UK government as a result of the UK’s internal markets bill, and the UK briefly calling off talks following the European Council summit in mid-October. Our base case remains that a deal will be struck and indeed negotiations that were called off have restarted with renewed vigour. Risks do, however, remain of a breakdown in talks, and any deal is likely to be narrow.
UK equity markets declined sharply at the end of October, ending the month down -3.8%. The pound fluctuated with Brexit headlines but ended the month at the same level against the US dollar as it started. UK 10-year Gilt yields rose by just over 10 basis points, resulting in negative returns in a month where UK equities also declined.
Exhibit 4: Fixed income government bond returns
China was the first country to suffer from the virus and has retained stringent controls since. October finally saw the relaxing of the internal controls restricting movement between provinces that China has kept in place since the outbreak. This has not, so far, led to a resurgence in infections.
China’s success in controlling the virus has allowed its economic recovery to gather pace, with third-quarter GDP growth printing at 4.9% year on year. After a strong bounce over the summer, China now looks set to be one of the only major nations that will see positive economic growth in aggregate over 2020 relative to 2019. Chinese imports have also recovered with the latest data for September showing imports 13.2% higher year on year. A resurgent Chinese consumer may help international exporters given the potential for weaker demand in their home markets.
Against this backdrop, strong returns from Chinese stocks helped emerging market equities to a 2.1% gain over October.
The fourth quarter of 2020 contains an unusually high number of unpredictable events for markets to negotiate. Market volatility in October was elevated as investors waited for a clearer steer from both the US election and the results of coronavirus vaccine trials before increased infections and subsequent lockdowns forced the market to re-evaluate the near-term risks. November is set to be another very busy month, and several key events should provide a clearer steer on the macro outlook for 2021. Binary potential outcomes call for balance in portfolios, and currently this applies across asset classes, factors and regions. The potential catalysts for a rotation between this year’s winners and losers in the stock market are getting closer, but there remains significant uncertainty around the outcome of the US election, the vaccine trials, Brexit negotiations and the scale and scope of policy responses required over the winter.
Exhibit 5: Index returns for October 2020 (%)
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