Market briefing – 3rd June 2020
With dividends from global equities expected to fall this year, it will be more difficult to manage the payment of regular income under the current global economic conditions.
Closer to home, the UK has historically had one of the highest profit pay-out ratios, thereby returning more of the profit in the form of dividends. Some companies, for example those within the energy sector, have been forced to cut their dividends due to the low oil price. In addition, the Bank of England has obliged banks to cut pay outs in order to preserve capital to help the economy, while the UK government has prohibited large corporations that have participated in its bailout loan scheme from paying dividends. Finally, a decrease in dividends in the UK is exacerbated due to the make-up of its main stock market index, the FTSE 100, which is dominated by financials and commodity stocks.
Equity funds that that are well-diversified globally and have a significant allocation to funds that invest in infrastructure companies and utilities, are likely to be less vulnerable to an economic downturn and should be more immune to cuts in dividends.
Given the market backdrop, diversification across assets and fund managers are likely to be better placed to provide a reasonable level of income protection.(1)
Having a global lens is essential
The impact of Covid-19 around the world is unprecedented and horrific. However, as we are dealing with a global humanitarian and health crisis, the economic impact of this pandemic shouldn’t be about profiting from other people’s tragedies. The key point for an investor is for their portfolio to be set up to benefit when the sustained recovery happens.
That’s certainly easier said than done when reviewing global indices, such as the UK’s FTSE 100(2) and US’ S&P 5003). The challenge is to work out which one will rally first and then whether that recovery will be sustained.
The S&P 500 saw a tempestuous fortnight in March where it suffered some of its worst days and then, thanks to a fiscal stimulus package, some of its best days(4).
The FTSE 100’s weighting towards the financial sector seemingly makes it the best placed index for a sustained recovery.
In either of the above scenarios, a good argument could be made to support which market will see a sustained recovery first.
The FTSE 100 index had already had a bumpy 12 months thanks to the Brexit uncertainties. However, following a decisive UK general election result providing clarity regarding an exit timetable, things had finally begun to settle down.
Then along came Covid-19.
As the graph shows…
… FTSE 100 stocks have been hit hard by the effects of the virus, the FTSE 100 was down 23.84% in the first three months of 2020, compared with a 14.23% drop on the S&P 500.
However, as this graph shows …
… the FTSE 100 has bounced back 23.9% as of 1st June from its 23rd March low, as optimism spreads that the virus may be slowing.
In the longer term, the FTSE 100’s recovery may well be boosted by the enormous business stimulus package provided by the UK Chancellor that permits thousands of companies to continue operations, and by extension, boosts consumer and investor confidence. A relaxing of the lockdown rules in the four UK nations may also help with this recovery.
The vast majority of FTSE 100 businesses are financially sound companies but there are concerns. The index contains a dozen energy companies, three times the percentage of the S&P 500, which could continue to be hit hard due to oil prices.
Covid-19 may have made these companies’ share price attractive, but the way they reward investors is primarily by paying dividends. As was mentioned in the ‘Update’ above, these could be less sustainable going forward.
Finally, the FTSE 100 has a significant exposure to companies with significant operations overseas. These create much of their revenues outside the UK. Therefore, their performance is reliant on how quickly those countries emerge from the pandemic and sterling movements with these foreign currency dominated returns.
Standard & Poor’s (S&P) 500
The pandemic crisis has emphasised the value of technology. The positive impact of this has been significant for the S&P 500 companies in the IT sector.
At the moment, the S&P 500 looks more like the S&P 5 — Facebook, Apple, Amazon, Alphabet [Google’s owner] and Microsoft are collectively worth nearly a fifth of the index’s entire value(6) with healthcare the next biggest sector.
As the graph shows …
… by the end of May, the S&P 500 has regained all of what it had lost since the end of February, suggesting that the S&P 500 was the place to be in the very short term.
However, the US is recording more Covid-19 deaths than anywhere else in the world, which would suggest a wider impact on the American economy. When combined with a record surge in unemployment claims and a highly likely sharp imminent recession, perhaps the longer-term future of the S&P 500 is not quite as encouraging.
Longer-term recovery is also possibly impeded by the S&P 500’s weighting towards the so-called BEACH industries: booking, entertainment, airlines, cruises and hotels. Disney, Booking Holdings (owner of booking.com and OpenTable), Expedia, and numerous US airlines are among communications and consumer discretionary companies that could suffer greatly for many months as, even if it is more relaxed, lockdown measures remain in place. The salient question is: even if they were open, can we honestly see millions of Americans returning to their great pastime and stream to the baseball stadiums straight away?
What should this tell you?
That investors should continue to keep calm and diversify.
While individual stock markets will continue to go up and down, smart diversification can help investors minimise their risks. An investor’s lens shouldn’t be focused on one country, let alone one stock market. Although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimising risk.
However, remember that no matter how diversified a portfolio is, risk and reward do typically go hand in hand and as such risk can never be eliminated completely.
It is true that the short-term horizons discussed enhance the uncertainty due to the unpredictability of this current situation. However, it is important to remember that we very often have a long- term investment time horizon.
As we have said before, we will continue to monitor the current financial situation and keep you notified of any changes that are made. Please seek professional financial advice if you wish to discuss your financial situation further.
(1) Based on information supplied by Square Mile Investment Consulting and Research Limited.
(2) The FTSE 100 (Footsie) is an index that tracks the 100 largest public companies by market capitalisation that trade on the London Stock Exchange (LSE). The FTSE 100 represents roughly 80 percent of the LSE’s market capitalisation. FTSE is an acronym for the Financial Times and the LSE, its original parent companies. The FTSE is now owned and maintained by the LSE. It has similar importance in London to the U.S. Dow Jones Industrial Average and S&P 500 and is a major indicator of the performance of the broader market – Investopedia.
(3) The S&P 500 or Standard & Poor’s 500 Index is a market-capitalisation-weighted index of the 500 largest U.S. publicly traded companies – Investopedia.
(5) FE Analytics
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