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The relative market highs did not last too long. This week we have seen markets revert to focussing on the current bad news, rather than the future hopes of longer-term recovery from COVID. The pull back started in earnest with the US Federal Reserve (FED) warning markets on Wednesday evening that the path to a full recovery would be slow. The FED expects to keep interest rates at near zero levels until well into 2022. On top of that, we have seen a large number of redundancies from some key global companies, such as BA, based on lack of demand. The IMF have again warned of the weakening global economic conditions and to top it all, infection rates in the US are on the up as the release from lockdown has been too swift and poorly implemented. A sobering week.
It seems a long time ago, but it was only earlier this week that the liquidity fuelled market rally saw the US S&P 500 index move back into positive territory for the year, while the tech dominated Nasdaq index closed at an all-time high on Wednesday. Since then, we have seen a market sell-off led by the value and cyclical stocks that had shown nascent signs of outperformance over recent weeks, the risks of which we discussed in our update last Friday.
At this stage, the uptick in US infection rates may not yet be a ‘second wave’, but more of a sign that the first wave of the pandemic still has further to go. States such as Texas have reported their highest number of cases since the pandemic began and there have also been notable re-accelerations in cases in California, Florida and Arizona. The US, and to a lesser extent the UK, have both been more aggressive in terms of ending lockdowns than we have seen across many European countries, where there remains no notable reacceleration in cases even as most of continental Europe returns to ‘normal’, with schools, bars and restaurants opening with social distancing enforced. The US has also seen the politicisation of the virus response and attitude toward reopening to a greater degree than other western economies – not surprising in an election year and given the personalities involved. The Johns Hopkins University Centre for Health Security, which has been collating case data ever since the pandemic began, noted that “there is a new wave coming in parts of the country (i.e. the USA). It’s small and it’s distant so far, but it’s coming”.
Globally, with confirmed cases now over 7.5 million, the concerns over increasing cases are predominately in the US and emerging markets, particularly Brazil, Russia and India. We are also seeing significant growth in case numbers across Africa. From a developed markets equities point of view, it appeared that markets had moved on somewhat from worrying about the pandemic with the focus on the strength of the recovery. This week’s news flow has been a reminder that both government and investor complacency can have consequences. It will be interesting to see how the US deals with a rise in the infection rates, should it continue. US Treasury Secretary Mnuchin said yesterday “we can’t shut down the economy again” and it does seem there is no political will to reinstate widespread lockdowns. Even without lockdowns, we will likely see consumer activity remain suppressed in areas where there are signs of the pandemic taking hold once again.
The FED also gave some insight into the path for asset purchases, saying they will continue with “at least their current pace” of $120 billion/month, adding that the FED “will continue to use the emergency powers forcefully, proactively and aggressively until the economy is solidly on the path to recovery”. There is clearly scope for the FED to do more if needed.
The OECD warned of the deep scars expected on the global economy as a result of the coronavirus pandemic. IMF Chief Economist Gita Gopinath said yesterday that the global economic recovery from the pandemic is slower than expected and also spoke about lingering scars.
We may have our attention elsewhere for the moment, but the latest round of Brexit talks that ended last Friday are worth a mention. Chief EU Negotiator Michel Barnier said that “the truth is there was no substantial progress” and that differences remain in the key areas around fisheries, competition rules, and governance, all of which were covered in the Political Declaration agreed last year. While the UK still appears unlikely to request an extension to the transition period, there may well be progress this month, with the Prime Minister set to meet European Commission President via videoconference on 15th June. While the EU27 may well be focused on the Recovery Fund at the EU Council summit on 19th June, it remains important for both sides, particularly the UK, to avoid the economic risks associated with the UK leaving without any form of trade deal come the end of the year. The Financial Times also reported the UK will implement ‘light-touch’ customs checks once the transition period comes to an end – the government claims to be taking a “pragmatic and flexible approach” due to the pandemic but given the time needed to set up the staffing and infrastructure required to enact the full customs checks that may be necessary once the new trading relationship is agreed, this was probably their only realistic option.
It has indeed been a sobering week for investors, although the market is stronger as I write today. We have reduced some of our US equity exposure this week in our discretionary mandates, favouring better value Japanese equities and some US Treasuries. There are many factors that can be blamed for the deterioration in sentiment and plenty of them have been with us for some time but have been ignored by equity markets helped by a wave of liquidity from the central banks as well as a lot of assumptions being made about the strength of the economic recovery. Those assumptions may now be coming under more scrutiny, but the fact remains that we will have to be patient to see how many of the ‘unknowns’ will play out and for the moment the breadth of possible outcomes on issues such as US politics, the pandemic and the economic recovery is very wide. The ‘invisible hand’ of the central banks and abundant liquidity remains ever present, however, and may well continue to underpin the market rebound. The reversal of the recent rotation in markets into cyclical and value names underlines the fact that we are likely to need more compelling evidence of a sustained pickup in economic activity before value stocks can consistently outperform. Perhaps a vaccine is needed both for COVID and for a longer-term recovery in value investing. For now, stay safe and well and we will continue to monitor markets and act accordingly on your behalf.