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Creation Commentary - August 2020

UK: Suitable for retail and professional clients

In this month's edition:

 

Market review

The equity market rally continued over the month, with some stock markets reporting their best August since 1984. With risk assets gaining ground (what’s referred to as a ‘risk-on’ environment), sovereign bond yields moved higher (meaning their prices dropped). Meanwhile gold, traditionally a safe haven during times of market upset, had a volatile ride; the gold price initially surged above $2,000 per ounce before finishing the month down -0.4%.

In the UK, the FTSE All Share Index had a strong start to the month, but the release of gross domestic product (GDP) growth data on 12 August seemingly signalled a turning point. The Office for National Statistics confirmed that GDP contracted by 20.4% in the second quarter, making it the deepest recession the UK has ever seen – and the worst of the G7 countries. Despite GDP growth data being marginally better than economists’ expectations, the UK equity market drifted lower for the remainder of the month to return 2.4%, having at one stage been up more than 6%.

Mega-cap technology stocks continued to be the driving force behind the US equity rally as many of these companies have benefited from the changes in living and working conditions brought about by the coronavirus. Technology giant Apple performed well, becoming the first US company to be valued at $2trn, while better-than-expected corporate earnings also helped to buoy US markets.

US and Chinese relations soured mid-month as President Trump announced restrictions on Chinese companies TikTok and WeChat, and a meeting to review progress on the Phase 1 trade deal was delayed. By the end of the month though, the US had reaffirmed its commitment to the deal and noted progress was being made towards the agreed goals. By the end of the period, the MSCI USA Index delivered a total return of 5.3%, eventually shrugging off the back-and-forth in trade tensions. Democrats and Republicans in the US Congress remained in a stand-off over a proposed fiscal stimulus package, the country’s second since the virus hit.

The Democrats’ already watered down $2.2trn proposal has garnered little support from Republicans, who favour a bill nearer the $1trn mark, raising the possibility of another government shutdown if the disagreement is not resolved.

Growing coronavirus cases in continental Europe, notably in France and Spain, weighed on European equities. Several countries reported negative monthly inflation rates for August, including Germany and Italy. Nevertheless, the MSCI Europe ex-UK Index ended the period generating a total return of 2.2%.

The MSCI China Index was not far behind the US, ending the month with a 3.6% total return. Chinese equities moved higher in response to a fresh wave of monetary stimulus as the Chinese central bank, the People’s Bank of China, injected 700 billion yuan of one-year funding through its medium-term lending facility.

At the US Federal Reserve’s (Fed’s) annual symposium at Jackson Hole, Fed chairman Jerome Powell announced a policy shift from a 2% inflation targe to a 2% average inflation target. This subtle difference means the Fed will tolerate inflation moderately above 2% for some time to make up for periods of lower inflation.

This change implies easy monetary policy, potentially for years to come, which initially drove longer-dated US Treasury yields sharply higher to compensate for higher expected inflation, but this move partly unwound in subsequent days.

Given the general market appetite for riskier assets it was unsurprising that US high-yield bonds fared better than Treasuries, with the ICE BofA US High Yield, GBP Hedged Index delivering a 1.0% total return during August, whereas the ICE BofA US Treasury, GBP Hedged Index fell by 1.19%.*

In the UK, the ICE BofA UK Gilt All Stocks Index also ended the period in negative territory, delivering a total return of -3.1%. In currency markets, euro strength has been a market theme since April, but the single market currency stalled a little in August.

Meanwhile, US dollar weakness continued through the month as the higher yield the dollar used to enjoy over other major currencies has disappeared since the Fed cut its policy rate due to the coronavirus. As the other major currencies struggled, sterling was well supported despite stalled Brexit negotiations.

(All performance figures in sterling terms and rounded to one decimal point, unless otherwise stated)

*Currency hedging of foreign investments removes the risk of currency fluctuations affecting the returns on your investment. Under normal circumstances, in the Creation Portfolios we currency hedge our foreign bond holdings.

Performance review

August was a generally positive month for the Creation Portfolios, thanks to the continued rise in equity markets, which led to the higher risk portfolios delivering slightly stronger performance.

During the month there were few changes to the equity portion of the portfolios, as although the overall equity allocation increased in the period, this was a factor of the continued rally in equity markets.

The effects of manager selection were negative overall as the continued outperformance from growth sectors meant that any manager with anything even remotely value-orientated struggled. Key detractors in the month included the Wellington Durable Enterprises Fund, the Quilter Investors Global Dynamic Equity Fund and the BNY Mellon US Income Fund. In contrast, managers with any growth-related holdings did very well during the period, including the Quilter Investors Equity 1 Fund, managed by Merian Global Investors, the JPM Emerging Markets Growth Fund and the Sands Global Leaders Fund.

From a fixed income perspective, our tactical asset allocation generated a positive return. Bonds in general were negative for the portfolios given the rise in yields over the month. However, credit spreads (the difference in yield between government bond and corporate bonds) did compress during the month, which helped offset some of the losses incurred by the sensitivity of the holdings to interest rate changes (duration).

Within our fixed income holdings we slightly increased the interest rate sensitivity in the portfolios (duration) through a small purchase of government bonds. This was beneficial to the portfolios as yields moved lower (and prices moved higher) towards the end of August. 

The alternatives allocations were also helpful over the month, contributing slightly to returns especially within the long/short space in the form of the Merian UK Specialist Fund. We made one change to the alternatives holdings, where we have replaced the PIMCO Dynamic Bond Fund with the Allianz Macro Fixed Income Fund. The return profile of the Allianz fund is much more suited to the alternatives bucket and we would expect strong performance in the case of a market sell-off. Similarly, the recent rally in credit meant that the PIMCO strategy had recently performed well and so we took advantage of the opportunity to crystallise the profits and reinvest the proceeds elsewhere.

Outlook

There are currently three main areas we are focused on as we move towards the end of the year, the most pressing of which is the prospect of a second wave of coronavirus cases causing further disruption in the US and globally. 
 
The increase in US infections has materially slowed, and hospital admissions are now falling. Having said that, US coronavirus-related deaths are running at an average of around 850 per day, which is materially greater than in Europe. As children return to school and temperatures cool at the start of autumn in the northern hemisphere, we would expect infections to increase but we would not necessarily expect to see such a strong surge in hospitalisations and deaths as experienced earlier in the year. The infection increase has so far been restricted by rolling local lockdowns, and if the situation does not deteriorate, equity markets are likely to remain optimistic and look towards a potential vaccine in the first half of next year. 
 
One immediate concern, however, is the inability of US politicians to agree on an extension of the emergency aid package. This has not had a large impact on consumer spending in the aggregate, but data shows that lower income families (who are more impacted by the federal aid programme) have reduced spending, whilst higher income families have not been impacted to nearly the same extent.
 
Meanwhile, attention has also shifted to Europe and the vacation-induced rise in infections seen in countries such as France and Spain. It should be noted though that hospitalisations and deaths remain very low in these countries – the larger issue is whether lockdowns will need to be re-imposed above and beyond the current protocols in order to eliminate the infection growth.
 
As the US presidential election draws closer, President Trump remains consistently behind in polls but these tend to overstate the chances for Joe Biden given the make-up of the electoral colleges, and so the race is closer than it might appear. Over the coming month we would expect renewed focus on both Biden and his Vice-President candidate Kamala Harris as they will be tasked with explaining their policies and crucially how to pay for them, in an environment of already huge budget deficits.
 
Considering the read-across to investment markets, investors (and particularly equity investors) have a strong aversion to uncertainty. With this in mind the spat about postal voting and the potential for increased voter fraud becomes more pertinent. It would seem that the odds of either candidate conceding if a close election appears to have been decided by vulnerable postal votes is fairly low (a similar risk to the “hanging chads” in the 2000 election) – this would be possibly the worst short-term outcome for markets following the election night.
 
Meanwhile, the continued rally in US equity markets has given rise to renewed fears about extreme valuations. US markets, in particular, look expensive on many traditional measures such as multiples of earnings, cashflow or book value. However, we recognise that through a multi-asset lens US markets can look relatively reasonably priced, when compared to very expensive government bonds and cash generating a yield materially below inflation. For those who perhaps don’t have the luxury of not being invested or those who rely on investments for income, there really is no other alternative.
 

Sacha Chorley

Portfolio Manager

Stuart Clark

Portfolio Manager

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