Prospects for world economic growth have been overwhelmed by the massive and unprecedented disruption caused by the coronavirus pandemic. However, business activity has now started to pick up as lockdown measures have been relaxed in many countries. The extent of this recovery has varied widely, depending on the severity of outbreaks of the virus and the capacity of governments to subsidise employment and wages. China was initially hit hard by the pandemic, yet its economy is now expected to grow by 3% over the full year. Latest expectations for the US still envisage a strong rebound, but this assessment may prove over-optimistic if rising cases of the disease force a widespread return of social restrictions.
Public sector borrowing is rising dramatically almost everywhere as a result of irresistible political pressure to ‘do what it takes’ to maintain living standards. At this stage, there is no evidence of any inflationary pressures arising from the resulting looseness of monetary and fiscal policies, but any sustained economic revival may well be accompanied by sharp rises in consumer prices.
Governments have directly intervened in an unprecedented way into a wide range of commercial activities. Financial and regulatory support for ‘national champions’ is likely to undermine competition at a time when international trading relationships are already under threat. Against this background, it is alarming that the nature of the UK’s future relationship with Europe remains unresolved. The US presidential election in November also looks set to be particularly divisive.
The asset allocations in the portfolio have been relatively defensive for several years, but the investment case for holding government bonds has weakened in the face of shrinking, and in some cases negative, returns. At the same time falls in equity markets earlier in the year offered some attractive investment opportunities, even if the outlook for earnings remains vulnerable in the short-term. Accordingly, the equity allocation was increased to 65% in March, with a corresponding decrease in the bond holdings.
Stock markets have rallied in recent months, reflecting assumptions that there will be a robust economic rebound in the second half of the year. Depressed interest rates are also supporting asset valuations. Much will depend on the availability of any effective treatment for the virus, but there appears to be an acceleration in the positive trends that already favour some of the fastest growing companies in sectors such as communications, healthcare and technology.
It is too early to make a definitive judgement on the shape of the recovery. Unsurprisingly, the reopening of economies has seen rising numbers of coronavirus cases. Recent sharp gains in share prices have left many equities looking fully valued. Our investment strategy continues to be relatively cautious. We favour a broad diversification of assets, including some allocations to bonds and gold in balanced portfolios.