14th December 2020
A fortnightly look at global financial markets by International Investment Strategist Tom Elliot.
The ‘risk on’ trade in financial markets continues
Shadows to be aware of: fiscal support being withdrawn prematurely, potential problems of vaccine take-up, and a no deal-Brexit
Sector rotation into cyclical sectors replaces tech as the dominant stock market theme
The E.U’s Euro 750bn post-pandemic recovery package is a milestone
Brexit and sterling: caution!!
Optimistic, less so in the U.K. Continuing high rates of Covid-19 in many industrialised countries have not deterred investors from betting on a steady global economic recovery once Covid-19 vaccines are rolled out this month. Global The S+P500 and NASDAQ reached new highs in the week just ended, and the FTSE 100 is at last taking part in the stock market rally, up almost a fifth since late October. Industrial commodities prices, which are often taken as leading indicators of economic activity, have risen sharply since November’s vaccine trial announcements, with copper and iron ore at seven-year highs. Safe haven assets such as the U.S dollar, and Treasuries, have weakened. Market sentiment in the U.K is tempered by nervousness over a no deal Brexit, which has becoming more likely over the last week.
Shadows to be aware of
1. Will government continue to provide fiscal support for the global economy until an economic recovery is complete?
In the U.S, it may seem to Republican Congressmen that it is in their political interest to curry favour with Trump and hold out against any sizeable stimulus package. This would substantially increase the risk of economic harm from the current wave of Covid. Trump is thought to be considering standing for president again in 2014, and may consider weak economic growth under a Biden presidency to be a political advantage.
Meanwhile it is noteworthy that the Euro 750bn recovery package agreed yesterday by the E.U heads of states is for post-pandemic spending and is not intended to support the region during the current wave of Covid.
2. Will vaccines be rolled out successfully enough to ensure herd immunity, and therefore the ending of social movement restrictions?
This is not just question for emerging economies that may have underfunded healthcare systems. Developed economies may have the logistical ability, and money, to do the roll-outs but political will might falter in the face of popular opposition.
The London Assembly Health Committee found in a poll done last month that a quarter of Londoners would definitely refuse a Covid-19 vaccine. More than half of these used You Tube as their main source of information on the vaccines, and they cited suspicion of governments and health care companies. ‘Anti-vax’ is a common strand of the populist politics to be found across the world, often mixed in with broader conspiracy theories. The London results are all the more striking because anti-vax is at a relatively low level, compared to the U.S, Italy etc.
3. Particularly relevant to the U.K: the growing risk of a no-deal exit from the E.U’s single market and customs area
At the end of last week financial markets were reasonably certain a deal would be done, and sterling -which has been the Brexit sentiment indicator since the 2016 referendum- rose to $1.35. Since then, lack of progress in talks has led to both sides warning of a growing likelihood of no deal, and sterling is down to $1.32. A no deal will have an initially chaotic affect on U.K supply chains, and if WTO food tariffs are applied will raise average food prices by around 3% (according to the supermarket Tesco).
OECD report and sector rotation
Investor sentiment this month has been helped by the OECD’s latest Economic Outlook, released on 1st December, which painted an improved outlook than that of its June report. For example, it expects the U.S economy to shrink this year by 3.7% (compared to 8.5% in its June forecast), while the Chinese economy will have grown by around 1.8% over the course of 2020.
Consensus estimates are for an average 20% gain in global corporate earnings next year, with greatest potential amongst the worst-affected sectors. This has helped fuel the rally in economically-sensitive sectors such as industrials, energy, mining and banks, while braver investors are looking at the shell-shocked transport, entertainment and hospitality sectors. Tech stocks have underperformed as a result. Some call this a rotation, which is not strictly accurate given the ongoing-highs of the NASDAQ. Money for investment in cyclical stocks is coming not so much from selling tech stocks, but from cash and government bond positions.
E.U Stimulus package agreed: important in many ways.
Last Thursday the E.U meeting of heads of state agreed its next seven-year Euro 1.8 trillion budget, and the Euro 750bn post-pandemic recovery package. It is the recovery package that is the more interesting.
The Euro 750bn is made up of a mixture of grants and loans, with some of the money to pay for these coming from borrowing. The implications are manifold. It will be the first time that the E.U has issued debt under its own name, and will be the first truly ‘risk free’ euro-denominated debt available to global investors, in the sense that that the issuer can repay simply by printing the required money. This is likely to be only the start of a longer process of E.U -backed bond issuance that will help promote the euro as a global reserve currency.
Second, it represents a further step towards common budgeting (ie, fiscal union) and pooling of political power. Poland and Hungary have had to concede the principle that Brussels can restrict funds to them if they transgress on ‘rule of law’ principles (notably a free media and independent judiciary).
Lastly, the money is to be distributed slowly – peak disbursements not being until 2014. It is not a medicine to help ease the current state of public finances in member states. To some, this is a drawback. To others, it will ensure better use of the money. It is intended for long-term investment projects, with a green bias.
Brexit and sterling
Despite its recent wobble, sterling (currently $1.33) remains relatively close to a level that many believe is commensurate with a deal being made. For example, JP Morgan offer an estimate of around $1.37 if a deal is achieved. But the downside risk is growing, as talks hit apparently insurmountable ideological hurdles. Some believe a 15% or greater fall in the rate is possible if no deal is agreed by the end of the month and the U.K reverts to WTO tariffs with the E.U in January.
After all, if the U.K focuses on retaining its sovereignty in talks, how can the it accept E.U environmental, state aide and labour protection laws (the ‘level playing field provisions’)?
Yet from the E.U’s position, why should they give the U.K something they have never given anyone else, which is free trade (ie, free of quotas and tariffs) without any conditionality? It should be noted that when Prime Minister Boris Johnson describes his goal as a ‘Canada’ deal he is misrepresenting the Canada/ E.U (CETA) agreement. CETA continues to use elements quotas and tariffs on certain products (though much reduced). Canada also agreed to move its domestic laws closer to those of the E.U on the ‘level playing field’ issues, while Johnson wants the ability to diverge from E.U laws in these areas.