COUNTERPOINT SEPTEMBER 2020

A new dawn

Businesses, governments and central banks are adapting to an evolving situation, with implications for investors everywhere

Many aspects of our lives are likely to be shaped for the rest of this year and beyond by ongoing social distancing measures. Yet as offices and schools begin to reopen after a long break, we’re optimistic about transitioning back to a way of life that is more familiar. There are already some encouraging signs from real-time data that economic activity is beginning to pick up, and governments and central banks continue to offer their support.

The most successful companies are likely to be those with the vision to adapt to the new environment. Businesses that provide their services over the internet have thrived during the lockdown but there are some things we’ll never be able to do online – such as getting a haircut. Quintet’s latest conversation about what it means to lead a richer life sees a banker and a barber talk about passion and tradition, which you can watch here.

As a result of Covid-19, restaurant-reservation website OpenTable has started to publish data which allows us to monitor consumer behaviour. The number of seated diners in Germany and the UK has recovered to pre-crisis levels, whereas the US continues to lag. Active consumers are a sign of economic health, but large gatherings create the risk of further virus outbreaks which could lead to tougher restrictions. We are monitoring this and other sources of real-time data closely to assess the possible impact on markets.

Since the oil price shocks of the 1970s, major central banks around the world have focused their energy on a single objective – keeping the rate of inflation around 2% so that their economies were running at just the right temperature. When conditions got too hot they would raise interest rates to slow things down, and when they got too cold they would reduce them to boost growth.

Central bankers are now changing their approach in response to the coronavirus pandemic. As our economies recover from the sudden and sharp recessions caused by the lockdowns, policymakers are worried about deflation, which could hinder growth. In response, the US Federal Reserve has just announced that it will be shifting to an average inflation target. The European Central Bank (ECB) will probably follow with a similar policy.

Although this change might not push up the rate of inflation immediately, it should at least raise inflation expectations. In theory, central banks will still have the flexibility to raise interest rates if prices start to increase too quickly. However, in practice they are unlikely to do so because governments need to be able to borrow money at affordable rates in order to pay for their massive economic stimulus measures.

How can investors navigate an environment of persistently low interest rates? After accounting for the rate of inflation, the real yield on offer from many government bonds is actually negative. That’s one of the reasons why the price of gold has risen so sharply this year, as investors have looked for other safe-haven assets. We also believe that as the recovery gathers pace the macroeconomic environment will continue to be supportive of equities and high-yield corporate bonds.

The strategy behind our model portfolio has not changed over the past month and we believe the current balance of traditional and alternative investments is appropriate for the economic environment. That includes overweight allocations to equities, in particular the technology and healthcare sectors in the US, as well as selective emerging markets.

We also see potential in some sectors of the corporate bonds market, specifically euro high yield and emerging market debt denominated in hard currencies. To offset various risks, we include assets that have historically been more stable during periods of market stress, including gold, US Treasuries and the Japanese yen. We have an underweight allocation to European government bonds and UK gilts, which look unattractive at today’s prices.