Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
Two great temptations for investors are to extrapolate from recent events, both good and bad, and to let sentiment cloud the facts. It is why markets overshoot in both directions. We are too bullish at the top of the cycle and too bearish at the bottom.
A powerful antidote to this tendency is to argue the case for the opposition. If you are feeling positive about the market, ask yourself what the risks to your optimistic outlook might be. If, on the other hand, you are worried about the future, try making a list of what could go right.
As I sat down to write this column at the end of last week, I had just heard that my holiday to France in a couple of weeks was off. My extended family in Melbourne and New Zealand had been thrown back into strict lockdown. I had spent the week writing about the evaporation of travel group TUI’s quarterly revenues and explaining why Britain had experienced the worst decline in economic activity since records began.
Against this backdrop, I’m rather sympathetic to the many investors who look around them and scratch their heads at why stock markets have recovered almost all the ground they lost in February and March. It is hard to think of a better time to road-test my ‘happy list’.
Fortunately, you don’t have to look too far in the financial services business to find someone willing to come up with reasons to be cheerful. Goldman Sachs’s head of global investment research, Jan Hatzius, duly stepped up to the plate.
Top of his list is the ongoing economic recovery around the world. He reckons we have already clawed back around half of the 17% decline in global GDP that happened between January and April, mainly on the back of recovering construction and manufacturing but also the first signs of life in the more important consumer services side of the economy.
We saw this clearly in last week’s apparently catastrophic second quarter data for the UK. The 20% fall in GDP all happened in the first month of the April to June period. Once lockdown started to ease, activity picked up quickly.
The initial broad-brush shutdowns of economies were an understandable reaction to a virus that we understood almost nothing about. But it is now clear that lockdown was a blunt tool that will probably not need to be repeated. We can now see that relatively simple and cheap measures to reduce infection rates - like wearing masks in public places - can be as effective as more draconian lockdowns but without the hit to GDP the shut-downs imply.
Measures such as the curtailment of group activities that facilitate super-spreaders will continue to be a fact of life for the foreseeable future, but these can be enforced while still enabling a resumption of economic activity more generally. There’s lots we can do to live with this virus that stops short of the stay-at-home mandate that we endured in March and April.
That is one reason to expect punchy economic growth figures as we move into 2021. Hatzius thinks the world will grow at 6.5% next year, with Europe and China expanding a bit faster still. This rate of recovery would be unprecedented, although it’s fair to say that the rate of decline that preceded it has been too. It’s a V-shaped bounce of sorts, although increasingly the Swoosh-shape (a truncated V tailing off into a flatter trajectory over time) looks more likely.
So, while it is easy to focus on the disaster stories from the corporate front line in retail, hospitality and travel, there will be plenty of sectors that learn to live with the virus - mask up, socially distance and carry on. Other key sectors like technology and healthcare may even be able to thrive in the new normal, which goes some way to explaining why the Nasdaq index stands more than 60% above its March low and 13% above its February pre-pandemic peak.
What else could go right? Another fascinating shift in the past two months has been in expectations about when widespread FDA-approved vaccinations will be available. Back in May, more than half of forecasters believed this was unlikely before the second quarter of 2022 and less than 5% expected positive news before the end of March next year. Today, those proportions have been reversed.
With Goldman Sachs attaching wildly different market scenarios to these outcomes (2,150 for the S&P 500 for the delayed vaccine outcome and 3,680 for the early jab), it suggests investors should pay attention to the vaccine news flow.
The final thing that could go right is what distinguishes this pandemic from earlier economic and market crises - the policy response. Chart work by my colleagues over in the US has shown the remarkably close fit between the market rally since March and those in both 2009, as we recovered from the financial crisis, and in 1930 after the stock market crash of the previous October. What is fascinating is what happened next: the recovery continued in 2009 for another 11 years, whereas it reversed in 1930, with the market falling for another three years until it had lost 86% of its peak value.
What was different? A few things, but the most important was the absence of monetary and fiscal support 90 years ago and the massive scale of it eleven years ago and, to an even greater degree, today. It took the New Deal and an explosion of war-time spending in the early 1940s to undo the damage of that huge policy error. Thankfully, 2009 is the better analogy today.
There is still a long list of things that could go wrong, but listing what could go right suggests there may be method in the market’s apparent madness.
Five year performance
|(%) As at 14 Aug||2015-2016||2016-2017||2017-2018||2018-2019||2019-2020|
Past performance is not a reliable indicator of future returns
Source: FE, total returns as at 14.8.20, in GBP terms.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.