Global Market Overview
A look back at markets in November, in which stocks made record gains amid a decisive outcome in the US election and several successful Covid-19 vaccine trials.
- Global equities rallied strongly in November, mainly due to several vaccines proving effective against Covid-19. The improved risk appetite saw corporate bonds outperform government bonds.
- US equities surged as vaccine breakthroughs sparked investor optimism that a return to economic normality is in sight. Joe Biden won the presidential election.
- In the eurozone, expectations of global recovery supported shares, with the region a particular beneficiary given its high exposure to global trade.
- UK equities performed well, helping them to recoup some of their year-to-date underperformance versus other regions. Sentiment was also helped by hopes that a “no-deal” Brexit might be avoided.
- The MSCI Asia ex Japan index recorded its highest return in more than four years. US dollar weakness amplified returns.
- Japan’s equity market rallied, driven by vaccine-related news and the slow-motion results from the US presidential election.
- Emerging market equities registered a robust return. Value outperformed growth, while Latin America and emerging Europe outperformed emerging Asia.
- Government bond yields were volatile during the month, with large swings around the US election and vaccines news. Corporate and emerging markets bonds performed well.
- Commodities delivered a positive return, aided in part by a weaker US dollar. Energy was the best-performing component.
In years to come, when people look back on the Covid-19 crisis and what was a torrid year for the world, November will likely be marked as a turning point. The announcement of three vaccines that are effective against the virus drove a risk-on mood in markets and added fuel to the post-US election rally, eclipsing worries about the near-term economic outlook. Equity markets cheered the light at the end of the tunnel, with this year’s biggest losers gaining the most in November: MSCI Europe ex-UK and FTSE All-Share indices returned 14.2% and 12.7%, respectively.
The year-to-date star performers, Asia ex-Japan and the US, still made impressive monthly gains of 8.0% and 11.0%. Global value stocks returned 15.1%, outperforming growth, which returned 10.9%. And in fixed income it was the riskier high yield and emerging markets that outshone the higher quality markets.
Over three successive Mondays in the month, markets were greeted by announcements that the Pfizer/BioNTech, Moderna and AstraZeneca/Oxford vaccines had been shown to be effective in reducing symptomatic cases of Covid-19.
With the first hurdles of efficacy and safety seemingly passed by all three, attention now turns to how quickly these vaccines can be approved, manufactured, distributed and administered on a mass scale. Here it is worth noting the logistical challenges of the 90% effective Pfizer/BioNTech and 95% effective Moderna vaccines, which both require cold storage (at -700C in the case of the former) and are relatively expensive.
The less effective (70%) AstraZeneca/Oxford vaccine is able to be stored at regular fridge temperatures and comes at a fraction of the price. With emerging markets having made their largest pre-orders for the AstraZeneca/Oxford vaccine, they stand to benefit from its approval the most.
An end to the Covid-19 crisis is now in sight, but the path to recovery may still be bumpy over the coming quarters as governments grapple to control the virus, particularly as seasonal factors make this more difficult through the winter. In Europe, significant restrictions to curb the spread of the virus look to have been effective, with new infections now falling sharply from their latest peak. In the US, the situation has continued to escalate, with new cases continuing to rise and deaths following.
High-frequency activity data shows the stark effect that the restrictions in Europe have had in slowing the economy. The question now is whether Europe is once again a bellwether for the US, and whether new restrictions and therefore a decline in services activity will be needed to contain the virus there.
In any case, markets are likely to digest near-term economic developments in the context of better times on the horizon, just as they did this month.
What was touted in many 2020 outlooks as the big event of the year – the US election – passed without upsetting markets. The unprecedented amount of votes being cast by mail-ins as a result of the pandemic meant that markets were made to wait to find out that Joe Biden will be the next president. And while the Trump campaign has filed legal challenges to contest several of the state results, we are confident that this will play out without any material changes in the result, given the margin of victory. Indeed the transition process from a Trump to a Biden administration is now underway.
There are two key policy implications from a Joe Biden victory.
First, the incoming president to take a more diplomatic and less confrontational approach in foreign policy matters, preferring to build pressure in a multilateral way and avoiding tariff measures, which come with greater economic costs, when possible.
Second, the US will reunite with its global peers in the effort to combat climate change, with the president-elect intending to re-join the Paris Climate Agreement on day one of his administration. We expect this to help drive the green agenda and shape the policies for global economic recovery in 2021.
As well as the presidency, the Democrats also retained control of the House. But control of the Senate – a key determinant of what any future fiscal stimulus may look like – will be decided on 5 January 2021 with two special run-off elections in Georgia. If the Republicans manage to win at least one of these elections, as looks most likely, then Republicans will control the Senate and Congress will be divided.
That event would be likely to herald a smaller and less far-reaching stimulus package than under a ‘blue wave’ scenario, but also prevent substantial corporate tax rises. Weighing up the prospect of less fiscal stimulus versus little change to corporate taxes, fewer trade war tweets and generally lower uncertainty, the markets on balance cheered the election outcome.
The economic recovery in the US has been proceeding at a good pace, but there are some signs that it is slowing. The flash purchasing managers’ index (PMI) surveys for November showed that both manufacturing and services activity was improving, with the indices both rising more than expected.
Labour market data for October also continued to improve, with the unemployment rate falling 1 percentage point to 6.9%. But the consumer is feeling more wary of late, with the Conference Board and University of Michigan’s confidence measures for November declining.
In the eurozone, the restrictions to contain the virus have once again exacerbated the gap between the paces of recovery in the manufacturing and services sectors of the economy. The manufacturing PMI for November slowed by 1 point to 53.8, while the services component fell 4.9 points to 41.3, indicating contraction. While businesses were feeling gloomier about the present, their expectations of future activity increased significantly.
Eurozone consumer confidence also took a knock in November, declining to -17.6 from-15.5. It now seems apparent that the eurozone economy will print a contraction in the fourth quarter. On the politics front, the leaders of Poland and Hungary effectively vetoed the European Union’s recovery fund and seven-year budget because the funding is conditional on upholding the rule of law. Negotiations are ongoing, but the intervention raises the risk of delaying members’ access to funds.
Like its counterparts in Europe, the UK government once again reintroduced restrictions to contain the latest outbreak of the virus. As a result, it recognised that businesses and households would need continued help throughout the winter and so announced the extension of the furlough scheme to the end of March.
The Office for Budget Responsibility forecasts that government borrowing will hit GBP 384 billion this year, or 19.4% of GDP – a figure not seen since the Second World War.
It is thanks to the efforts of the Bank of England (BoE) to keep Gilt yields so low that the government has been able to continue to finance these much-needed support measures throughout the crisis.
With the near-term economic outlook darkened by the latest restrictions, and more government spending needed, the BoE announced that it would expand its asset purchase facility by a further GBP 150 billion, GBP 50 billion more than had been expected.
With vaccine news signalling that there is light at the end of the tunnel, uncertainty around the length of the Covid-19 crisis is beginning to fade, which in turn is brightening the outlook for risk assets – despite the difficult winter ahead for the economy.
Within equities, the outperformance this month of this year’s losers makes sense, with a return to normality now on the horizon. As the economic recovery plays out, earnings expectations should continue to recover providing continued support for equities.
In the last couple of months, emerging markets have fared far better than their developed market counterparts. November was no different but this time the strong relative performance was less to do with a lower escalation in Covid infections, but rather to do with the promising news of multiple three Covid-19 vaccines due to be released in the coming months. High beta economies like South Africa rallied strongly thanks to resumption in risk taking with market participants starting to pencil in a more “normal” 2021.
The turn in sentiment globally was noticeable in various asset classes and themes that have lagged throughout the year. Value significantly outperformed growth, and the breadth of market gains at a sector and asset class level locally was the broadest we have seen in many years.
The most depressed equity sectors such as listed property and the local banks were the best performers, gaining 17.5% and 19.5% respectively. Within the various sectors there were some eye-watering returns, for example: Sasol up 44%, Nep Rockcastle up 37%, Mr Price up 32%, and Investec up 29%.
The gold miners were the worst performers in November, as save haven assets were sold down heavily, and the strengthening Rand acted as a major headwind. Gold Fields, Harmony and AngloGold fell 24%, 21% and 12% respectively.
For some time now, local government bonds have offered very generous real yields that has underpinned a floor for local fixed income investors, but foreigners have been too nervous to dip their toes thanks governments obvious debt problem. But in November, it appears that this tide may also be turning.
Foreigners were net buyers of R12.1bn worth of local bonds, particularly on the long end of the curve (where the default risk premium is a dominant factor). Part of the demand for longer dated bonds was thanks to comments from Treasury who indicated that in they are considering spreading issuance more evenly across the maturity structure and reintroducing floating rate notes.
Inflation unexpectedly rose to 3.3% in October, largely due to a broad uptick in food prices. However, this did not deter bond investors thanks to the strong appetite for risk. The All Bond Index gained 3.3% for the month. The Rand followed risk assets higher, appreciating 5.2% against the US$ during the month.
It was not a surprise to see the MPC keep rates on hold for the second consecutive meeting with the vote split unchanged where only 2 of the 5 members in favour of a cut. The committee guidance for inflation and growth was lowered, but according to their quarterly projection model they do not anticipate any further rate cuts.
Economic data released in November suggests that Q3 growth figures could very well be higher than the fall registered in the 2nd quarter. A strong rebound is broadly anticipated by the market, but investors will be focusing on the magnitude of the reversal in the coming month.
Output still remains depressed and below the levels seen 12 months ago, but this is even the case in most developed market economies. Local business confidence continues to improve while consumer confidence remains hasn’t rebounded as strongly, sitting near 30 year lows. Employment figures remain very weak.
Cause for concern is the Covid resurgence in Covid cases in the Eastern Cape and the Western Cape, especially if government chose to follow the drastic measures seen earlier in the year. One could expect more localized measures, because the local economy simply cannot afford anything like we the national lockdown earlier in the year. For now, the state of disaster will remain in place and we would be surprised if it were lifted before year end.
November was a fresh reminder that the markets respond to changes in expectations rather than changes in reality. How quickly pharmaceutical companies are able to deliver their vaccines is still relatively uncertain, in fact only one out of trial patient to date has been inoculated worldwide but a few months ago, a successful vaccine in itself was a big uncertainty.
Investors in the local market will be looking to a successful distribution of the vaccine in the coming months, but more importantly an effectively implementation of the much need structural reforms detailed in Cyril’s growth plan discussed in October.
As would be expected, the V-shaped rebound in risk assets since March has been dominated by “pandemic winners and safe havens” such as the FAANGM megacap tech stocks. That phase looks to be going through some consolidation as investors shift to “return to normal” themes, with vaccine-related relief drawing nearer. There will be volatility, with the pandemic raging in Europe and accelerating in much of the U.S. Still, the end point is clear.
The pandemic is no longer the major driving force behind forward-looking capital markets, even as it poses a serious near-term threat to U.S. and European economies. Part of the shift is typical of bull markets. Improving economic prospects prompt a change in leadership from early cyclicals, which benefit from monetary stimulus, to late cyclicals, which benefit from strong economic growth and pricing power.
This time around, however, excess liquidity will persist much longer than usual. Central banks around the world, especially the Federal Reserve, have made it clear that they will welcome above-trend economic growth and above-target inflation. That increases the odds of a steeper yield curve, continued dollar weakness, strong money and credit creation, and even manias in financial markets including the FAANGM tech stocks.
In our mind the critical question for markets has moved from Covid to whether the Chinese government will make the same mistake as its done twice in the last decade . China’s economic policy has been a source of uncertainty for the world economy post the Global Financial Crisis (GFC). Beijing’s deleveraging campaign has caused periodic deflationary slumps in China’s economy and risk assets around the world.
In our view, it is almost certain that Beijing will tighten credit policy again. At present, total social financing is growing at 38% per annum — a speed that is obviously not sustainable. The central bank will try to slow it down at some point. The question is when and by how much the central bank will rein in credit creation. Our sense is that the economy is still in the early stages of recovery, and business confidence remains fragile.
In addition, inflation is undershooting, with core CPI inflation flirting with deflation. Corporate defaults are also on the rise. All of this suggest that the government will likely keep policy loose, at least until the second quarter of 2021. Beyond that time, however, it is hard to tell how Beijing will recalibrate its monetary policy. Our sense is that the risk of policy tightening could escalate, especially if property prices start to zoom up again, or if financial market speculation begins to inflate asset prices excessively.
Fund and Portfolios Overview
The Iza Portfolios all had a strong November along with most risk assets. What was particularly pleasing is that even with the growth bias and rotation to value all portfolios managed to keep pace with peers/benchmarks and are still significantly outperforming on a YTD basis . This was largely driven by Scottish mortgage which notched up a double digit return for the month in USD (16%) and GBP (10%) .
Key drivers of performance for SMT were the large moves in EV manufacturers Tesla and NIO. Lindsell Train also outperformed broader equities due to vaccine sensitive holdings in WWE and Disney. The balanced fund also benefited from its global property exposure as cyclical stocks bounced. Gold took a breather and was down for the month which is understandable given its safe haven status the rush for more risk on. We still believe Gold offers the best low-cost hedge against bumps in the road and with the USD expected to continue to weaken, support for the yellow metal remains intact.
All the portfolios continue to underweight duration and government bonds which has proved beneficial as bonds offered no downside protection during the Sep/Oct bouts of weakness and have backed up closer to 1% on the US 10YR late November early December.
We also recently added a new Fund – “Smithson” to the equity armoury of the Iza Global Balanced and Equity Fund. The Smithson Fund managed by Simon Barnard takes the already tried and tested Terry smith formula and applies that to the global small/mid cap space. This is one of the biggest draws of Smithson as Barnard adopts an identical approach to its highly popular (and highly successful) ‘big brother’ Fundsmith Equity Fund, run by Terry Smith.
Buy great companies, try not to overpay, and then do nothing. We think this fund will be a valuable addition to any portfolio looking to capture returns on offer in the global small and mid-cap space. Especially if the portfolio already has an allocation to the flagship Fundsmith fund. One could look to split the holding between the two funds if looking for more diversification but similar style.
However given the very different holdings can also simply treat as a standalone addition. At this point in time the small and mid-cap space looks very attractive given the large outperformance of the Mega caps the last couple years and room for catch up.
While this fund doesn’t necessarily buy into the largest laggards in this space being value, it will no doubt pick up on some of the rotation sentiment and of course the continued stable compounding of capital that has served Fundsmith so well will also likely add tremendous value over time.