Post-Covid markets?

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As the world struggles through unprecedented times, The Sovereign Group continues to work diligently to ensure their clients are supported and kept up to date with the ever-changing global financial markets. There has never been a greater need for clients to be reassured or assisted with their fiscal affairs. The Sovereign Group specialises in wealth management, trusts, retirement and succession planning and corporate services to establish and support businesses around the world. MARK CLUBB from Team Asset Management, one of Sovereign’s advisors with over 39 years’ experience in the financial markets, has shared his thoughts about these times.

Global economic growth and activity will be epically terrible in the first half of 2020. Economists are forecasting unemployment in the United States hitting 13% this year. It may go higher.

Morgan Stanley is predicting between a 38% and 45% drop in global GDP for the second quarter of 2020.

With a moderate rebound, the total for the year may be around -4%. Clearly, one can be more or less optimistic. What we know is that it won’t be a quick return to business as usual.

The war against Covid-19 will end, but with a whimper not a bang, and companies will be reluctant to rehire. Consumers will be reluctant to spend. Two key components to economic growth.

This is not the first, nor will it be the last, major economic shock or externality the world economy has or will experience. What we know is that, after these episodes, the world isn’t the same. We get a “new normal”.

There remain fabulous opportunities. Microsoft have consistently given above-average returns – “Microsoft was built for the Covid-19 crisis”. Recently, the company announced its cloud business Azure saw revenues rise 775% in many regions. Working from home is a massive boost for companies that provide IT infrastructure. This trend is only getting started. The shift to the cloud is expected to be worth $623 billion by 2023.

The world has been hit with the fastest onset of a bear market ever. The question facing investors is whether to buy on the dip or dips. The belief is that markets bottom before economies do. Problem is that it normally takes more than one massive decline before we see the bottom. In 15 bear markets since 1950, only one did not see the initial major low tested again at least once within three months. That was 1980-82. I expect the news flow to worsen before it improves. Another test appears likely.

There are typically three types of bear markets:
1. Structural – like the 2008-2009 downturn, driven by financial bubbles or other structural imbalances.
2. Cyclical – happen more as a function of the business cycle.
3. Event-driven – triggered by an exogenous event, like an energy crisis, political instability, war, or a pandemic. Event-driven bear markets last around nine months and take 15 months to recover.

Bull markets need buyers. The demographics in the developed world are a massive pension problem. Every day, more “baby boomers” are retiring. This generation is retiring in the 10,000’s a day.

Interest rates are zero and bonds yields near zero. US Treasury 10-year bonds currently yield 0.6% but inflation is 2.5%. Equivalent UK bonds 0.3%. The German -0.45%. The S&P dividend yield is 4.3%, FTSE All Share is 4.46% and Dax is 3.35%.

Pension funds will be driven into equities in the hunt for income.

Dividends are a function of profits which are functions of economic activity. But not all companies are going to be hit. Some will prosper.

We are going the see a separation within the market. The “divs” and “div nots”. The “div nots” will be zombie companies, controlled directly or indirectly by States. Utilities, transport, infrastructure and banking will be State-controlled. Public infrastructure spend will keep the construction industry alive, for example, but on inflation-linked contracts and profit margins.

These “div nots” will not pay “real” dividends for some time/years. They are effectively nationalised.
The “divs” will be the companies outside controls. I think we will return to the “Nifty Fifty”. In the US during the 1960/70s, there were 50 companies regarded as solid buy-and-hold stocks. Between 1960 and 1973, the S&P went up 200% but US GDP only rose 77%. The average p/e in 1960 was 17.2 and finished in 1973 on 18. Today it is 18.3.

Assume S&P yield were to halve to 2.15%, equities still offer 3.5 times more than bonds. Strong dividend-paying equities will be in demand. Pension funds have no choice. They have liabilities to pay. It’s about buyers and sellers.

We forget the reason to invest in shares. The clue is in “share”. A “share” of the assets, the profits (losses) and the returns through dividends. Because of the risk (it’s a company), this return needs to be above “risk free” like a government bond. This “Equity Risk Premium” (ERP) is the total return over a “risk free” asset (government bond). Bonds currently yield no more than 0.6% and average ERP is 3.5%, so investors should expect an average return from equities of 5% per annum for the next 10 years versus 0.6% per annum from bonds.

This is a crude measure of markets; but you could see ERP go to 7%-8% because of income. Then you would be expecting 8%-9% pa on average from equities over 10 years.

I and we at Team have our “Nifty Fifty for 20/30”.

Shelley Wren, The Sovereign Group’s new Global Investment, Residency and Citizenship Consultant, is able to assist with any queries and concerns individuals may have regarding their assets, investments, or even for a financial health check. Contact Shelley on swren@SovereignGroup.com if you would like to have a virtual meeting or chat via the telephone.

Keep calm and meet the experts at Sovereign Group.

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