Cambridge Weekly – 28th September 2020

The Cambridge Weekly Update

A recovery on hold

September continues to bite equity markets. Stocks everywhere wobbled again last week and even though
they bounced back, the S&P500 is down around 8% in US Dollar terms for the month. UK investors might
notice less of a fall, with global equities down just 1% in sterling terms. This is partly due to the fall in
sterling itself, with the pound suffering yet again from adverse Brexit news.

Despite the drama in stock markets, bond markets have been eerily calm. Government bond yields have
been stable – not falling amid stories of the impending economic slowdown, but likewise not rising in
disapproval when governments around the world issue vast amounts of new debt. This inert response has
good and bad implications. Immovable bond yields allow governments to borrow at practically non-existent
rates indefinitely, helping them reflate their lagging economies through fiscal action. But from an investment
perspective, flatlining yields break the inverse relationship between bonds and equities. That hinders the
risk offset that bonds provide investors, making multi-asset portfolios riskier, at least in the short-term.

FinCEN files – don’t bank on banks?

Given the roller-coaster week it has been for markets, the economy and everything else, you would be
forgiven for missing a story about bank reports. But last week’s release of the FinCEN files – so called after
the US Financial Crimes Enforcement Network – contained plenty of intrigue, from fraud and money
laundering to Russian oligarchs and terrorist bank accounts. Leaked documents covering the period from
2000 to 2017 show that the world’s biggest banks allowed at least $2 trillion of suspicious transactions to
go ahead, in what investigative journalist Fergus Shiel called an “insight into what banks know about the
vast flows of dirty money across the globe”.

The usual suspects all made appearances, with JP Morgan, Barclays, HSBC and Deutsche Bank all involved
in reporting fraud, money laundering or breaking international sanctions – among many others. Regrettably,
the City of London also had many mentions in the files, with over 3,000 UK companies named in the
suspicious activity reports – more than any other country.

Reflation reality check

As rain and wind flush out the heat of the last few months, there’s a noticeable chill in the air for capital
markets. For investors, things looked bright between June and August. The economy was finding its feet
again, lockdown restrictions continued to lift, and central bankers were committed to indefinite monetary
accommodation. As such, the ‘great reflation trade’ looked on. A rebounding global economy with
practically unlimited monetary backing, and a healthy dose of fiscal support, caused inflation expectations
to climb back up from their lows – taking US equities past their record peak. So far though, September has
been one long reality check for those expectations.

To some extent, the sell-off in asset markets over the last few weeks may be an exercise in profit-taking
for investors who have enjoyed impressive gains for the last five months. But headwinds have undoubtedly
parched market optimism: an uptick in virus cases and resumed restrictions in the UK and Europe, as well
as an increasingly uncertain political landscape in the US, have left investors wondering if they got ahead of
themselves. In contrast to the downturn in equities, bond yields have stayed virtually flat, despite a pick-up
in real (inflation-adjusted) interest rates. This signals a decline in inflation expectations.

Read the full commentary here