FTSE 100 enjoys government boost, but can the market rally last?
There have been two bits of good news for the UK index today, the first is the news that Vodafone had a decent set of results for Q1 and is honouring its dividend pledge. There has been a dearth of good corporate news stories and dividends in recent months, so this was warmly received. However, the latest news from the Chancellor, that the UK will continue to pay the wages of workers on leave because of coronavirus until August with a smaller amount to be paid through to October, has cheered the markets. But will it be enough?
The Chancellor gives deadline to get UK economy moving again
The market’s enthusiasm for this scheme is to be expected, especially when other advice from the government, such as its plan to ease the lockdown, has been rightly criticised for lacking in detail. The positive market reaction, the FTSE 100 is up more than 1% so far this afternoon after a fairly lacklustre open, was down to the fact that the announcement from the Chancellor was a shock. There had been some speculation that he was going to cut short the furlough scheme and reduce the amount of support the government was going to give companies. If this had happened, then the FTSE 100 would have most likely fallen sharply as it would have threatened consumer demand and the future profits of many FTSE 100 and 350 companies. By extending the scheme in full through to August, employers and employees can breathe a sigh of relief. However, the Chancellor has now hit the ball into the Prime Minister’s court. The underlying message contained in the Chancellor’s speech is that the government’s roadmap to get the economy moving again has to be successful. The UK’s economy needs to be functioning by August; at that time the government will only help businesses to transition their employees back to work, with the scheme ending in October. The message from the Chancellor is clear: the economy has to be fully functioning by October, with or without a vaccine to eradicate Coronavirus. While the UK’s business and employee support scheme has been generous, what if a second spike of the virus occurs in the Autumn or winter, will there be enough fire power to help out businesses and pay for a second furlough scheme if that is the case?
Should we be planning for a second wave of the virus?
Thus, while we can understand why financial markets have cheered the Chancellor’s statement today, we believe that the upside could be short lived. If the current easing of some lockdown restrictions leads to another spike in the infection rate, then we could see stricter measures enforced once more. That scenario would be negative for UK asset prices in our view. As we have said from the beginning of the “recovery” in asset prices, this crisis is not over. While the financial markets have been able to withstand weak economic data and rising death rates across the developed world, we don’t think that they will be able to cope with a second spike of infections that may cause another suppression of the global economy.
Investors get more defensive
Interestingly, the companies that performed the best on the FTSE 100 today include Ocado, Morrisons, Vodafone (due to the earnings report) and Primark owner Associated British Food. This is a mixed bag of companies and there is no unifying theme. Surprisingly, the companies that are the weakest performers on the FTSE 100 today ware also some of the biggest users of the government’s furlough scheme, for example, Intercontinental hotels, Whitbread and Compass Group. Thus, we believe that the boost to the FTSE 100 could be temporary, as investors return to the more defensive sectors of the FTSE 100, like supermarkets and tech and comms firms, rather than betting on a recovery for hotels and leisure industries. This suggests to us, that the strength of the recovery rally in global stock markets could start to tail off in the coming days and weeks.
Overall, we believe that a second wave of the virus could prolong lockdowns and temper economic growth for the rest of the year. We also believe that we could have an L-shaped economic “recovery” for a longer period of time than people expect. Without a cure or a vaccine, and with the second wave of the virus likely to strike down the younger and healthier sections of population (if older and sicker sections are shielding), we believe that the second wave of the coronavirus could be deadlier than the first wave. This happened during the Spanish flu, and there is no reason why this wouldn’t be the case now. If that happens, or if markets think that it will happen, then we could see the broad stock market rally peter out in the coming weeks. Below we look at three markets that we think can best weather a second wave of coronavirus.
1, Government bonds
Governments will have to borrow record amounts to support their economies through this crisis. There are two reasons that we are not too worried about this, and why we don’t think that this pandemic will lead to a global sovereign debt crisis: 1, record low interest rates, and 2, unlike you and me who have to pay back every penny of their debt, governments can “grow” out of their debt, and continue to borrow money even when they are highly indebted. This week the US government is launching a 20-year bond for the first time in nearly 30-years as demand for US debt continues to grow.
2, Tech
This crisis has highlighted how crucial technology is to our lives. The lasting impact from the coronavirus could be the use of more technology in our lives. Remote working and video conferencing could become more acceptable and possible, also the use of online subscriptions and delivery services to allow us to do our favourite gym class at home or have a meal from our favourite restaurant delivered to our door could also become more ubiquitous. Zoom and Just Eat have seen record high share prices during this pandemic. This, along with the outperformance of tech giants like Netflix, Microsoft and Amazon have helped the Nasdaq to recoup the vast majority of this year’s losses. We believe that the Nasdaq 100 is resilient to another spike in coronavirus infections and economic lockdowns and should continue to outperform other stock market indices for the rest of the year.
3, ESG investing
One area that we are less confident about is oil. The head of BP said today that we could be past “peak oil” and that demand for oil may never recover. This is a concern for the FTSE 100 as it has a large and important energy sector, as does the Dow Jones in the US. This is why we prefer the Nasdaq to both of these indices. Of course, the demise of oil could also see an uptick in green energy companies growing in significance. ESG investing, which incorporates green energy, may also become more popular. The iShares Trust ESG MSCI ETF has recovered strongly since bottoming out around the 24thMarch. Companies included in ESG ETF’s are easily outperforming their carbon heavy energy rivals and are also keeping pace with the parent index. Thus, one outcome of this pandemic could be an increased interest in green energy and the ESG sector overall. We will write about this in more detail later on.
Good luck trading this week.