Prudential - T&IO Market Updates
31 July 2020
Current tactical positioning
In funds where we implement TAA positions (excluding PruFunds), we maintain an overweight stance in high yield credit owing to the favourable technical environment, where major central banks continue to use credit markets to provide stimulus to the real economy. At present, we retain a neutral view on equities and continue to follow the trajectory of the virus and the associated lockdown measures. The portfolio managers also continue to hold a small position in UK REITs across all of the Prudential Risk Managed Active and Risk Managed Passive portfolios.
Market and Economic review
Positive news flow early in the week regarding the European Recovery Fund and the safety of a number of COVID-19 vaccine frontrunners did little to boost equity markets and by Friday there was a distinct risk off tone with the Stoxx 600 opening down 1.6%, US equity futures –0.8% and the FTSE 100 down 3% on the week, triggered by a mix of Sino-US tensions and concerns the US economic recovery is stalling. Assets thought to exhibit a correlation to inflation reached all-time highs, in response to the negative real yields available on US government bonds. After a period of underperformance, emerging market equities outperformed developed markets this week, which themselves were mostly led upward by the US. In bond markets, US, UK and German yields fell, driven in part by concerns over economic growth and implications for long-term interest rates. The spread between perceived riskier Eurozone bond markets (such as Italy) and Germany tightened thanks to confirmation of the European Recovery Fund. European high yield tightened over 15bps from last week.
Alongside a characteristic volte face on the dangers of the Coronavirus and its potential impact on the US economy (contributing to weakness in the US dollar), President Trump was also instrumental in escalating geopolitical tensions with China this week. Citing spying concerns around research into a Coronavirus vaccine, the US ordered China to close its consulate in Houston. This triggered a swift riposte from Beijing, calling the move a significant violation of “international law and basic norms of international relations” and retaliated by ordering the closure of the US consulate in Chengdu. Earlier in the week, President Trump signed legislation giving his administration additional powers to sanction Chinese officials following the decision by China to impose a national security law on Hong Kong, in addition to an order that restricted special privileges previously afforded to the financial centre. Across the pond, UK MPs faced criticism for failing to properly investigate allegations of election interference by Russia. As the week progressed this turbulent geopolitical back drop, combined with the narrative of a V-shaped economic recovery looking ever more fanciful, resulted in a distinct change in sentiment from the buoyant feel of previous weeks.
A significant development occurred in the Eurozone this week, following a weekend packed with negotiations. The EU agreed a €750bn Recovery Fund to boost the economy and stimulate investment, with €360bn in low interest loans and €390bn of grants. Considerable compromises were needed to agree the package, including increases in EU contribution rebates to several members as well as a reduction in the fund’s size. Nevertheless, it represents a galvanisation of the European project and will result in the ECB becoming a material issuer in bond markets. The structural implications are still embryonic, but it could result in the ECB becoming the new Eurozone benchmark bond, replacing Germany. In a post-Brexit world it also represents a philosophical renewal of the single currency, bringing a level of fiscal integration that could help in future crises.
This week the UK budget deficit stood at £35.5bn in June alone, leaving UK debt at 99.6% of GDP. The Office for Budget Responsibility forecast a deficit of £370bn for the year (the highest level since WW2). More positive UK data included retail sales which rose 13.9% in June as COVID-19 restrictions eased further. US mortgage applications were down to 4.1% from 5.1% last week while existing home sales increased 20% from May to June, benefitting from a broader reopening of the economy and buyers taking advantage of low mortgage rates. US initial jobless claims rose this week to 1.4m marking the first increase since March. Along with total US infections now in excess of 3.9m, there are concerns for what impact these numbers mean for the economic recovery.
The Eurozone underlying inflation rate slowed in June compared to May, rising 1.1% compared to 1.2% last month and remaining some way short of the ECB’s 2% longer-term target. US economic data showed some signs of deceleration in output, some of which likely relates to base effects following the sharp rebound following March and April’s standstill in activity, but potentially also reflects the US’ struggles to fully reopen for business. Hard data such as building permits rose 2.1% compared to a 14.1% increase in May. On the positive side, June saw 1.186m housing starts compared to a forecast of 1.169m alongside upward revisions to the prior month.
Forward looking data from the Michigan Sentiment Index fell from 78.1 to 73.2 in July, short of expectations of continued expansion to 79.0, putting the sustainability of the upswing at risk. A number of temporary benefits programmes designed to support the US economy during the lockdown expire at the end of July. Until recently the Republicans have been against further support, believing it disincentivises work, but have now said they will consider extending unemployment support through to December.
Unilever reported strong sales of hand soap and ice cream which led to underlying sales beating expectations, resulting in a sharp increase in the share price on Thursday. Daimler also fared better than expected with a positive free cash flow for 2020 and demand gradually recovering, particularly in Asian markets.
Outlook
In the week ahead data releases include the Fed funds target rate decision, US consumer confidence, US durable goods orders, Eurozone M3 money supply, IFO German business climate, UK mortgage approvals, Eurozone unemployment data, China manufacturing PMI and a slew of US earnings including Apple, Google, Amazon.
