A seasoned hiker could have walked from Brussels to Amsterdam in the four days that Europe’s leaders took to agree on last week’s €750 billion recovery fund. But the lengthy talks appear to have provided a much-needed boost to the continent, and reassured investors in the process.
As the markets grew more confident that the deal would make it over the line, the euro strengthened against the dollar.
European stocks also rose on the news – Germany’s DAX stock index even popped into positive territory for the year, before slipping back later in the week as global stocks fell on news of fresh US-China tensions (see below).
Last week’s deal “would have seemed unthinkable prior to the pandemic”, argues Mark Dowding of BlueBay, co-manager of the Strategic Income fund at St. James’s Place.
But it demonstrates how Europe’s leaders have risen to the challenge of COVID-19, he says, and shows that “the European project is in fact a community of common values with a common destiny.”
Some are less convinced about the deal’s long-term significance. The agreement is a “fudge” and a “missed opportunity” to sort out some of the long-term problems in the eurozone, argues Rob Jukes, Chief Investment Officer at Rowan Dartington.
Not enough of the deal consists of grants (which don’t have to be repaid), while it falls short of the step towards true fiscal union that it could have become, he adds.
So how should investors be thinking about Europe?
“Because Europe is home to lots of exporters, it is well placed to benefit from a global recovery in the short term,” says Jukes. He adds that the continent has also dealt quite well with COVID-19, and is more insulated from the political issues in the US and UK that make those markets look a little riskier. Speaking about the recovery fund’s impact, Jukes adds: “There is definitely a short-term win here for Europe.”
Some recent data support the idea that there is cause for optimism: companies across the euro area have recovered relatively quickly so far in the second half of the year, according to data from IHS Markit on Friday.
The corresponding data for the UK showed that activity is rebounding, even though it’s hard to tell what shape the recovery is taking. On Friday, data showed that UK retail spending is now back to pre-virus levels. However, Capital Economics warns that the increase is disproportionately due to online spending and the fact that consumers are saving elsewhere: “We think it will take until 2022 for GDP to recapture its pre-virus level.”
Despite the positive news from Brussels, last week also provided plenty of challenges for world markets.
Increased tension between the world’s largest economies saw the US order China to close its consulate in Houston, Texas, amid claims of intellectual property theft. Beijing retaliated by ordering the US to shut down its own consulate in Chengdu, in south-west China.
The news sent global stocks downwards on Friday, driving the price on five-year US Treasury bonds to new lows, and prompting gold to reach $1,900 per troy ounce – another recent high.
Meanwhile, the weekly number of Americans applying for unemployment benefits crept up on Thursday to 1.4 million – the first increase in four months.
Similarly alarming was news about COVID-19 in the US. According to Pantheon Macroeconomics, even though the seven-day rolling average number of new coronavirus cases has fallen in 25 US states, new case numbers are rising increasingly quickly in some other states, and a spike in California last week raised some concerns.
Out of Office
Microsoft reported its quarterly results last week. The technology giant’s earnings significantly beat Wall Street expectations, proving that some companies are thriving amidst the challenges posed by COVID-19.
However, a slowdown in the growth of its cloud-computing arm did weigh on its share price as the week continued.
“Microsoft is certainly benefitting from the fact that the world is working from home, and that our children are … playing a lot of Xbox. So, the absolute numbers that they were able to achieve in the quarter were quite impressive”, notes Jim Henderson of Aristotle, manager of the St. James’s Place North American fund, which holds Microsoft, as well as other tech winners such as Adobe and PayPal.
Microsoft, and other Big Tech players like Amazon, Facebook and Alphabet, have enjoyed a stellar quarter. Their surging share prices mean they now account for roughly a quarter of the total market capitalisation of the S&P500 Index. This said, US tech stocks dipped on Friday, perhaps in response to fears about their increasingly large role in the market.
But fears of tech stocks being overvalued are misplaced if investors continue to focus on companies’ long-term strengths, says Henderson.
He notes: “Have technology businesses got ahead of themselves in terms of their share prices? We don’t think so, in the case of the companies that we own, because we’re looking at intrinsic business values over longer periods of time.”
The thinktank suggests that the transfer of wealth between generations will go on to determine how well-off people become, and this is likely “to have important implications for social (im)mobility within younger generations,” said David Sturrock, a senior research economist at the IFS.
The report has practical implications for the tax-efficiency of inheritance money that is gifted and received in the years to come. The government is under pressure to introduce taxation reforms that address the deficit, which has ballooned since the start of the coronavirus crisis.
A review of Inheritance Tax (IHT) has been underway since 2018, and could be an area where reforms are introduced to reduce relief (as opposed to increasing it).3 With receipts reaching record levels of £5.4 billion last year4, IHT is a particularly lucrative tax for the government and may be a first port of call when trying to balance the books.
Under current rules, assets of the deceased are exempt from paying any Capital Gains Tax (CGT). However, a review of CGT was announced in July, which means there’s a possibility that the tax may change on death.
The introduction of a so-called ‘wealth tax’ to further reduce the deficit and reduce inequality in the UK could have additional implications for the transfer of wealth between parents and their children in the coming decades.
The Autumn Budget may be when we find out more about the extent of the government’s taxation reforms. Now could be a good time to review making lifetime gifts before the tax rules are potentially simplified into something less generous.
3Office of Tax Simplification: Inheritance Tax Review, November 2018
4HMRC, September 2019
In The Picture
Learn these basic investing principles to help turn your goals into reality.
The journey to achieve your goals isn’t always easy. Unexpected events can take us by surprise, while uncertain periods can cast shadows over our financial outlook.
The coronavirus pandemic has shown just some of the challenges that we can face in our lifetimes, including concerns for our health, job security and economic prosperity.
During these uncertain times, it’s helpful to be reminded of some basic investment principles that give us the best chance of achieving our personal goals.
This video looks at some of the principles that can be applied throughout your financial journey.
The Last Word
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Aristotle and BlueBay are fund managers for St. James’s Place.
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