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Generation Monthly - May 2020

UK: Suitable for retail clients

Rest of Europe and Singapore: For sophisticated investors only

Date: 12 June 2020

Sacha Chorley

Portfolio Manager

Ian Jensen-Humphreys

Portfolio manager

In this month's edition:

 

Market review

May saw a number of major countries taking the first steps toward easing their respective lockdown restrictions. In most cases, such moves were tentative due to the risk of a second wave of coronavirus (covid-19) infections.

Official figures released in May showed that the UK economy shrunk by 2% in the first quarter of 2020, the largest quarterly fall since 2008, as the lockdown restrictions impacted economic growth. Even so, the FTSE All-Share index shook off concerns of a looming recession to gain a modest 3.4% in sterling terms.

Elsewhere, the UK sold government bonds with a negative yield for the first time, while the Bank of England’s new governor, Andrew Bailey, said he wouldn’t rule out negative interest rates. The ICE BofA 1-10 Year UK Gilt index was up just 0.4% by the end of the month.

Earlier in May, the third round of talks between the UK and EU started up in a bid to define their future trading relationship. However, an exchange of public letters between the chief negotiators illustrated that the process had got off to a frosty start.

In Europe, the Italian government approved a second coronavirus support package worth €55bn, while early estimates for the first quarter suggested that German GDP growth had contracted 2.2% quarter-on-quarter. This was the biggest quarterly drop for the eurozone’s largest economy since the global financial crisis. Despite the poor economic data coming out of Europe the MSCI Europe ex UK index delivered 7.8% during the month, making it the top performing regional market in May.

In the US, covid-19 deaths topped 100,000 as President Trump’s handling of the crisis came under fire. The publication of non-farm payroll data showed that more than 20 million people in the US lost their jobs in April. In spite of this, the MSCI USA index ended the month 7.3% higher.

In May the US also held its first sale of a 20-year bond since 1986, prompting a fall in US 10-year and 30-year Treasury bond yields. During the month, the ICE BofA US Treasury index notched up a minor gain of 1.7% for sterling investors as higher-risk bonds raced away; the ICE BofA US High Yield index delivered 6.7% over the month.

Towards the end of the month, anti-racist demonstrations calling for an end to police violence broke out across the US, placing Mr Trump’s administration under further scrutiny. 

Trade tensions between the US and China also flared up as the president threatened to hit China with new tariffs. Mr Trump has continued to blame China for the covid-19 outbreak and announced that the US would be withdrawing from the World Health Organisation (WHO), which he claims is too biased towards China.

Meanwhile, China held its annual meeting of parliament, in which it announced it would abandon its GDP growth target, citing the uncertainty caused by the global pandemic. During the meeting, the National People’s Congress also announced further fiscal stimulus and offered more support for small and medium-sized companies.

However, the decision to impose national security laws on Hong Kong prompted protests to restart in the region. Despite having been one of the first countries to exit lockdown, the MSCI China index made only a modest 1.5% gain in May.

Emerging market equities made minor progress in sterling terms, with the MSCI Emerging Markets index notching up a return of 2.8% during the month. In May it also became clear that emerging markets were struggling to contain, or even adequately track, their respective outbreaks.

By late May, Russia was thought to be the second-worst impacted country after the US while an explosion in covid-19 infections had pushed Brazil into third place globally, with India rising ominously up the rankings. India’s number of infections hit a new high the same day it decided to resume internal flights as part of its lockdown easing.

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

 

Performance review

May was another month of positive returns for the Generation portfolios thanks to the continued rise in risk assets like equities and bonds as major economies began to slowly wind down their lockdown measures.

We allowed our underweight equity position to drift slightly higher over the month as global markets rose, but we remain broadly cautious on the outlook and have maintained our overweight position in cash as a result. Given the uncertainty over the retreat of quarantine across much of the world and the risk of a re-acceleration of covid-19 cases, we think this only prudent.

Our underweight to equities may have detracted from relative performance slightly but this was partially offset by the positive returns delivered by our corporate bond holdings where prices rallied in line with improved investor sentiment

In general, manager performance was strong in May and our manager-specific changes within the portfolios were limited.

During the month we removed a small position in Riverstone Energy, an oil and gas-centric private equity trust. We also reduced or sold out of our positions in the Merian Financials Contingent Capital (CoCo) Fund and the Wells Fargo US Short Term High Yield Bond Fund, to take advantage of the recovery both had enjoyed since their March lows.

Elsewhere in the fixed income portfolio, we reduced our exposure to UK government bonds (gilts) and rotated into US government bonds (Treasuries) to take advantage of the greater yield on offer and the potential for superior performance in the event of another loss of investor risk appetite.

 

Outlook

The global outlook remains particularly cloudy as populations start to emerge from their lockdowns. Possibly the most important data for markets comes from the periodic updates on new covid-19 cases from regions that are loosening their restrictions.

To date, the readings have been cautiously optimistic and this, along with renewed support from central banks and governments, has pushed risk assets higher with many traditional valuation metrics rendered temporarily irrelevant.

With a raft of institutional cash still sitting on the side-lines, there’s also the possibility of further gains to come as underweight investors are forced back into the market. So far, this rally has been especially ‘fragile’, powered for the most part by a few mega-cap technology stocks; there’s been little sign of the market exuberance spreading to other industry sectors.

We expect that further incremental good news and reduced covid-19 cases will be required to sustain this rally. Meanwhile, a second wave of infections would likely trigger another sharp decline in markets and another delay to when we might see a return to economic ‘normality’.

Bond yields still have room to move higher from here although central banks will be keen to maintain loose financial conditions and this should cap any losses if investors suddenly decide to sell their government bond holdings.

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