A fortnightly look at global financial markets by deVere Groups, Senior Investment Strategist Tom Elliott.
14th September 2020
- Recent tech stock volatility not to be confused for a broader ‘risk-off’ sentiment
- Negative real interest rates and corporate earnings upgrades support equities
- Downside risks include a too-quick withdrawal of government support to economies, and renewed general lockdowns
- Sterling weakness, more volatility is expected
- The Internal Markets Bill – a U-turn coming?
Market sentiment: volatility has returned to global stock markets. But it is hard to see a major correction for equities in the current loose fiscal and monetary policy environment. Neither voters, or the bond market, show any sign yet of resenting the huge amount of new government debt created since March with more yet to come. Furthermore, if inflation starts to rise, rising negative real interest rates on bank account cash and government bonds will increase the relative attraction of equities for all but the most risk-averse investors. Perhaps the most significant risk to equities, and other risk assets, lies in a too-quick withdrawal of government support for the economy should the political consensus for fiscal stimulus begin to fracture, and before vaccines become available.
Market volatility has been sector specific. The NASDAQ index of U.S tech stocks is currently 10% down from its 2nd September all-time high, after a short but significant correction. Tesla -a NASDAQ darling amongst U.S retail investors- is down 25% from its 31st August high. It is unclear what triggered the sell-off, however, analysts had been warning for some weeks of high valuations in the tech sector. Tech valuations became further stretched after recent share splits from companies such as Apple and Tesla, with many retail investors apparently misunderstanding why the stock had become -apparently- cheaper.
However, outside of the U.S, the impact of the correction on NASDAQ has been surprisingly muted. Certainly, global stock markets fell as fears grew of a broader correction. However, cyclical-biased sectors bounced back and the German and Japanese stock markets are up slightly since the start of September, as is the U.K’s FTSE 100 (helped by a weaker pound).
Other indications that the turmoil is limited to the tech sector, rather than a broader worry over risk assets, can be seen in the performance of asset classes usually judged to be ‘high risk’. For instance, over the last fortnight, the Bloomberg Global High Yield index is broadly unchanged from the start of the month. Emerging stock markets and global smaller companies are both down slightly, but not by as much as the more tech-heavy MSCI index of global developed large caps.
What’s underpinning the market?
1) Negative real interest rates. The environment of very low interest rates is perhaps the most important support for stock markets at present. And it looks set to continue, with most major central banks now stating a willingness to wait for inflation to emerge rather than launch pre-emptive strikes, which may risk choking growth. The U.S Fed is the most vocal in this, but the ECB is not far behind in its rhetoric (it should be recognised that ECB’s loose monetary policy is also driven by currency considerations, as it tries to stop the euro rising against the dollar). It is not just key overnight interest rates that will remain low, since central banks’ bond purchase schemes will continue to buy up large quantities of government and commercial bonds, so depressing yields on all fixed income markets.
Since inflation is above the key central bank interest rates in most major economies, we have what is called ‘negative real interest rates’. In this environment, there is little incentive for investors to hold cash or short-dated government bonds. Investors are forced into higher risk debt, or longer maturities, where yields are higher. And into equities. As inflation picks up with economic recovery, we can expect pressure on investors to take on more risk in their portfolio, through buying credit and equities, to increase.
2) Global economic recovery has triggered improved corporate earnings estimates. ‘Good in parts’ might describe the global recovery that has been taking place since May, with different sectors experiencing very different levels of recovery in demand. Across developed economies, manufacturing and construction sectors have been able to return to work relatively quickly. But at the opposite end of the spectrum, people-facing service sectors such as high-street retail and hospitality, and airlines, remain weak. Meanwhile, tech and parts of healthcare continue to have a strong year. This pattern can be seen in the outperformance of the NASDAQ (ie, tech) since late March, compared to the German and Japanese stock markets (led by cyclicals), which have in turn outperformed the U.K main market (dragged down by a relatively high exposure to services, and sectors reliant on services such as U.K retail banking which now largely exists to help Brits sell homes to one another).
But corporate earnings estimates have been net positive for more than a month in the U.S market, according to Goldman Sachs. This means that upgrades outnumber downgrades. We expect this to be seen increasingly in other countries as consumer confidence steadily recovers – assuming governments hold their nerve and continue to support their economies until vaccines are available, and do no rush to re-impose general lockdowns as the number of cases of Covid-19 increases.
Sterling weakness, with more volatility is expected. After giving sterling a gentle few months, the FX market has responded to the news of the U.K government’s proposed Internal Market Bill with a vengeance, sending the pound down 4% last week against the dollar to $1.28, and to Euro 1.07. Analysts are bracing themselves for further volatility in sterling. In addition, the sterling/ dollar rate will be subject to dollar-related volatility as we approach the November presidential and Congressional elections.
The Internal Markets Bill – a U-turn coming? The Internal Market Bill’s sponsors are clear that it will explicitly break last December’s Withdrawal Agreement (WA), agreed with the E.U, and which is legally binding. But they see it as a last resort in order to secure the right to enact state aid policies free of E.U oversight, while Boris Johnson says he did not understand what he as signing in December. The U.K is looking to allow state aid to support up-and-coming sectors, rather than aged and declining companies.
Aside from opposition to the breaking of international law coming from his own Conservative Party, which is also uncertain as to the merit of state aid in principal, the U.K government appears heading for a tangle with other trading partners on this issue. The U.K/Japan trade deal announced on Friday has (according to the Financial Times) clauses on restrictions on state aide that tie the U.K’s hands in this area at least as much as the clauses in the WA. A U.K/U.S trade deal has been held up over British reluctance to accept American food and agricultural products, the Internal Markets Bill creates another problem. Nancy Pelosi, leader of the Democrats in the U.S Congress’ House of Representative, has reiterated a longstanding commitment to stop Congress ratifying any U.K/U.S trade deal that threatens the Good Friday Agreement (GFA), although the U.K government denies the GFA is at risk.
A U-turn by the U.K government appears likely.