The markets have demonstrated something of a penchant for risk since the start of June and global equity markets have risen by more than 3%.
At the same time, certain US macroeconomic data has deteriorated in line with market expectations, with factory orders and sales of consumer durables both plummeting by around 15% month on month.
In May, though, two crucial pieces of data brought a wave of optimism to the US markets.
Firstly, the unemployment rate, which the Bloomberg consensus expected to be 19%, was in fact just 13% according to the Bureau of Labor Statistics’ numbers.Secondly, retail sales were double the market’s expectation, posting an increase of 17,7% over one month rather than 8,4%.
This was the backdrop for the meeting of the Fed’s FOMC (Federal Open Market Committee) on June 10th to decide on monetary policy. If the Fed’s forecasts had the markets worried, their concerns were short-lived: it is now predicting a negative economic growth rate of -6,5% for 2020 and an unemployment rate of 9,3%. Nonetheless, its announcement that its key rates would not increase before 2022 at the earliest was a clear restatement of its unconditional support for the economy, with the aim of reducing unemployment and nearing its inflation target of 2%.
Economic data in Europe contained no pleasant surprises. The PMIs, the main indicators of confidence, are around 30 in France and Germany, while the boundary between growth and contraction is 50. That said, the lockdown easing measures and political progress in terms of the common stimulus package put forward by the European Commission have led to a degree of optimism in the European markets.
Lastly, this dual trend is also reflected in the foreign exchange market, where both a greater willingness to take risks and increased political enthusiasm in Europe helped the euro to gain ground against the dollar, rising to 1,12 from 1,09 at the end of May.
For the moment at least, nothing looks likely to jeopardise the upward trends seen in the markets. Investors appear to be becoming used to the unprecedented nature of the situation and are playing it by ear, letting valuation multiples unwind on deteriorated fundamentals and hoping to reach acceptable levels once again following the recovery that is expected in 2021, in order to avoid a correction.
Rationality has gradually given way to a much more behaviour-based approach. Market movements are being dictated by macroeconomic news, political solutions, business updates and lastly, hope, which has become a very viable investment case in recent months.
Growth stocks, which are a particular feature of the Tech sector, continue to post strong performances. On the whole, they offer sound fundamentals, managed debt, relative resilience to the crisis and enhanced growth prospects thanks to the acceleration of secular trends such as the uberisation of the economy and the dematerialisation of spaces.
There is a drawback, however: the valuation levels of these equities call for caution, especially since there could be a rotation in the medium term in favour of discounted, more cyclical stocks.
The constant expansion of the central banks’ bond purchase programmes and government stimulus packages – like the additional USD 1 trillion to finance the development of transport infrastructure and the rollout of 5G across the US – could speed up the recovery and the emergence of small increases in inflation that would tend to favour Value. Although the valuation gap between Growth and Value on the S&P 500 fell below 200% in June, it is still at levels not seen since 2000-2001. In the same vein, the Russell 2000 and European indices are gradually starting to make up ground on the Nasdaq.
Furthermore, this rotation could also be buoyed by the recent explosion in the number of independent or private investors, who will tend to favour highly discounted, cyclical stocks. Some were even prepared to contribute to the +900% jump in the Hertz (HTZ US) share price between May 26th and June 8th, after the company filed for bankruptcy.
Nevertheless, we continue to maintain a neutral positioning in the equity markets as there are many factors that could still temper investor sentiment. The recovery is proving less dynamic and more gradual than expected, and the new outbreak of coronavirus cases in the Beijing area and in certain US states could stoke fears around the emergence of a second wave of the virus, trailing a new correction phase in its wake.
US treasury bills continue to be much sought after, with demand supported by the quantitative easing programme and inflows of foreign capital. The key rate remained unchanged at the most recent meeting of the FOMC and the statements issued following the meeting were a non-event. The FOMC believes its policy is appropriate and has now confirmed its ultra-accommodative tone and forward guidance. The Fed also stressed the “considerable risks to the economic outlook over the medium term”. In this regard, it has pledged to make additional efforts, should they prove necessary, and do everything within its power to support the economy by keeping rates low and focusing on lending to the most critical sectors.
No particular concerns were expressed about inflation and what matters here are the forecasts. The scope of the stimulus measures introduced by the Fed and by Congress are expected, however, to keep them firmly anchored. The Fed will also continue to play its role in budgetary measures: in particular, the Treasury has the funds to increase the scale of the private sector initiatives. Meanwhile, the US Congress has approved additional measures resulting in a total stimulus package of nearly USD 3 trillion. The issuance programme, which includes long-term bonds, will help the market to absorb increased duration.
Turning to Europe, we remain cautious as we wait to see how the recent agreement between France and Germany, which seeks to create a recovery fund, is greeted by the EU member states.
The focus of the ECB’s action at its most recent meeting was its new asset purchase programme. This includes an increase of EUR 600 billion in the PEPP (Pandemic Emergency Purchase Programme) budget, taking the total to EUR 1,35 trillion. The Bank also announced that it was extending its purchases until at least June 2021, and that payments from securities that matured in the meantime would be reinvested until the end of 2022.
In conclusion, we are still neutral on duration and on sovereign bonds, as the combination of budgetary and monetary policies should maintain bond yields within their current range.
The credit market has remained relatively stable over the last few weeks. Initially, investor concern about a second wave of coronavirus muted appetite for risk in both Europe and the US. Risk premiums on corporate debt widened by around 10 to 15 basis points on both continents as a result, affecting cyclical sectors in particular.
This trend was quickly offset in mid-June, however, when the Fed announced that it was going to purchase corporate debt directly, and no longer solely via ETFs. This initiative is direct evidence of additional support similar to that already put in place by the ECB, and it provided investors with considerable reassurance, for two reasons: Firstly, it reiterates the Fed’s unconditional support and its responsiveness. Secondly, the Fed’s action is more direct, since the demand it creates prevents businesses’ borrowing rates from skyrocketing. This gives them the option of refinancing their debt under more favourable conditions.
This measure has benefited credit worldwide, and risk premiums are back to square one: yes, they are at a level comparable to that seen at the start of the crisis, but are continuing their downward trend that began following the peak in March. This state of affairs confirms our positivity to the asset class both in Europe and the US, particularly to high quality issuers where fluctuations in risk appetite have less of an impact.
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