Five key questions for the fourth quarter

As the fourth quarter gets underway, investors face an uncertain outlook. Political uncertainty has moved center stage in the final run up to the US election, with President Donald Trump’s positive test for COVID-19 further clouding the picture. A fresh US fiscal stimulus bill remains stuck in congress, with a large gap between the Republican and Democrat proposals. Last week’s non-farm payroll data pointed to a slowing of the jobs market recovery. Renewed outbreaks of COVID-19 have prompted the re-imposition of restrictive measures in the UK and France, with further restrictions under consideration for New York city. Equity market implied volatility remains elevated, with the VIX index trading close to 30.

Against this backdrop we look at some key questions clients have been asking us.

Will political uncertainty derail the equity rally? Over the near term we can expect short-term volatility to continue. The first presidential debate highlighted the divisive and acrimonious nature of the contest and pointed to the potential for a contested election result. President Trump’s efforts to push through his nomination for the Supreme Court and now his positive test for COVID-19 have introduced new issues that make the remainder of the election campaign more uncertain. But election uncertainty is a nearterm issue. Over the medium term we expect sustained improvements in mobility based on the development of a vaccine, and the eventual passing of additional US fiscal stimulus to shift the economy toward “more normal” and support further gains in equities. Read more on navigating the US election here.

Is tech a bubble that’s about to burst? We think tech is not in a bubble. The rally to date falls far short of the boom phase of the dotcom bubble, which pushed global tech sector valuations to 62x earnings, compared with current valuations around 25x. Current valuations also appear justified given expected earnings growth of 18%, which gives a price/earnings to growth ratio of 1.4x. Over the past five years, there have been a number of corrections in the global tech sector, which typically have led to 10%– 12% peak-to-trough pull-backs. The drop in September in the global IT sector reached 10% at its deepest point. That said, the narrowness of the tech rally and the shift toward a bi-polar tech world coming from the rivalry between the US and China for tech supremacy are both arguments in favor of a diversified approach. We recommend gaining exposure to a broad range of investments that are set to benefit from trends accelerated by COVID-19.

Will cyclicals and value continue to recover? After record underperformance, value has started to recover some ground against growth. Since the 2 September equity peak the Russell 1000 value index has fallen 4% compared with an 8% drop for the growth index. Rotation out of tech in September has been prompted in part by investor perceptions that a shift is underway to more normal economic conditions as economies fully reopen and recover. As noted above, we think this shift will occur, but the timing is uncertain. For a more sustained recovery in value we need to see the path to “more normal” to become better established, and also, given the support to growth stock valuations from low rates, to see interest rates move higher. The latter is likely to be some way in the future, and so we recommend a selective approach, focusing on areas of the market that have lagged the recovery so far. We like UK equities, US mid-caps, emerging market value stocks, and global industrials. Read more here.

What does central bank policy mean for markets? During 3Q the Federal Reserve adopted an average inflation targeting framework, and European Central Bank president Christine Lagarde has said a similar shift is under consideration. The Fed’s latest economic projections suggest rates will be on hold until at least the end of 2023. The major central banks are pointing to even more accommodative policy for even longer. Investors are being pushed harder to find yield We expect real returns on cash and high grade bonds to be negative for the foreseeable future. However, while credit spreads have tightened, we still see value in credit as a means of income generation. We like USD-denominated emerging market sovereign bonds, European crossover bonds, green bonds, and Asia high yield bonds. We also see opportunities in high-dividend paying stocks.

Should you invest in SI now? In short, yes. Momentum is growing behind sustainable investing as governments are incorporating the green agenda into their COVID-19 recovery plans. Investors are joining the trend. Over USD 1 trillion is already invested in dedicated sustainable investment funds, up from USD 600 billion just 18 months ago. Sustainable investment products are demonstrating comparable or better financial performance than conventional equivalents in a volatile market environment. For example, 72% of self-declared SI funds ranked in the top half of their Morningstar categories for the first half of the year. A focus on sustainability can also highlight opportunities in disruptive innovation— including companies involved in the transition to a low carbon economy, waste management, and the future of food. Sustainable investments are now our preferred solution for private clients investing globally.

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