Outlook for the 2nd half of 2020
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Ed Margot, Chartered FCSI, Chartered Wealth Manager, Investment Specialist
The first half of 2020 was one of the most turbulent ever seen as a market crash was followed by record levels of government and central bank stimulus. As we enter the second half of the year we look at some of the scenarios that could play out over the next six months.
We’re just past the halfway point of 2020 and there has been a lot for investors to digest so far. US equities have managed to hit record highs both sides of the coronavirus sell-off, while government bonds hit record low yields, gold is at its highest value in eight years and the price of oil hit $20 a barrel – after briefly turning negative in one remarkable trading session back in April.
2020 has also seen a record level of government and central bank stimulus with trillions of dollars of financial support, interest rate cuts and yet more trillions of dollars, yen, euro and pounds worth of quantitative easing.
Although many countries are in the process of trying to get back to something close to normality, the coronavirus pandemic is nowhere close to being brought under control. By the end of June there were 10 million confirmed cases of Covid-19 around the world, with the rate of new infection running about 1 million new cases each week.
That hasn’t stopped a lot of debate about what shape the economic recovery will take. Some commentators are still holding out for a V-shaped, quick return to pre-coronavirus levels of activity, while others debate whether we will see a drawn out U-shaped or a W-shaped recovery as economies have to repeatedly shut down to deal with recurring outbreaks of the virus. We’re not in the business of making short-term market predictions, so we’ll leave the reading of the tea leaves to others.
The performance of many asset classes so far has been distinctly V-shaped. The sell-off in March was one of the fastest corrections recorded and will be remembered for the precipitous and simultaneous decline in almost all asset classes. But the recovery has been almost as broad-based.
Sovereign bonds, investment grade corporate bonds and US and Japanese equities are all up for the year so far. The second quarter of the year saw US equities recording their best quarter since 1998. Other asset classes such as UK equities are still down for the year, but recovery has been swift and the three months to the end of June was the best quarter for UK equities since the financial crisis. Even oil, which saw its price fall from almost $70 a barrel at the beginning of the year to $19.50 in April, has seen its price more than double since its low.
Outlook for Q2
There are a lot of factors that have the potential to shape the direction of financial markets over the next six months. These include Brexit negotiations, an increase in tensions over international trade between the US and China and between the US and the EU, potential political unrest in Hong Kong and, not least, the ongoing coronavirus pandemic.
Coronavirus remains the most significant factor in the performance of equities in the second half of the year. If the outbreak of Covid-19 is brought under control quickly the damage to the global economy will be limited and a faster recovery will help support equity values. The best case would be the swift development of an effective vaccine. On the other hand, recurring waves of the virus causing repeated shutdowns will be damaging to equities, particularly if governments begin to withdraw economic stimulus.
In addition to the coronavirus, equity markets are also likely to be affected by politics. At a local level, the UK faces yet another Brexit deadline. With the government opting not to extend the transition period, both sides need to reach an agreement by the autumn in order for a trade deal to be signed off by national parliaments. Elsewhere, with relations strained between the US and China there remains the possibility for the fledgling trade deal to unravel and there is also growing tension between the US and Europe. The presidential election in the US also raises the possibility of volatility in what looks set to be a bitterly contested election.
The coronavirus is also likely to play a central role in the performance of fixed income securities over the rest of 2020. In addition to the chance that the economic damage caused by the coronavirus is worse than expected, the actions of central banks will continue to drive markets. The size of stimulus programmes announced by central banks calmed sovereign and corporate bond markets, and bond purchasing programmes are likely to be maintained over the next six months. Markets have so far absorbed the huge volume of new government and corporate bonds without yields creeping up. Inflation has remained well below target in most developed economies and is unlikely to be an issue for the rest of the year. However, with interest rates at record low levels and record amounts of stimulus already deployed central banks are running out of options to deal with a further sharp deterioration in economic conditions.
Other asset classes
The outlook for commercial property remains uncertain, with the full impact of the coronavirus shutdown unlikely to be seen for some time. The retail sector is already feeling the strain, with bankruptcies a very real risk. Other areas, such as warehousing, have benefitted from the boost in demand for online retail. Any change to the demand for office space will depend on whether the move to working from home becomes permanent for many employees or if employers need more space to accommodate their employees in a socially distanced workplace.
The price of oil has more than doubled from its March low, but oil producers are reduced their long-term forecasts to reflect lower than expected demand as the global economy recovers from the coronavirus. Industrial metals such as copper and iron ore are back to their pre-March values as demand is disrupted less than anticipated. The price of gold is at its highest in eight years and demand is likely to remain high if government bond yields remain low and if inflation does begin to pick up.