Investment Outlook 3rd July 2020
A fortnightly look at global financial markets by deVere Groups, Senior Investment Strategist Tom Elliott.
- Global stock market rally continues as lockdowns end
- Market volatility remains high
- deVere continue to favour a ‘U’-shaped economic recovery
- Is the U.S stock market overvalued?
Market sentiment: Investors remain ‘risk on’, with global stock markets continuing to re-claim the losses made in February and March. This reflects anticipation of a strong rebound in the global economy from the third quarter, as lockdowns are lifted, and confidence in a sharp recovery in corporate profits, both helped by central banks’ loose monetary policy. However, markets are somewhat volatile, with June seeing two days of over 2% falls on world stock markets (both of which were followed by quick recoveries). The VIX index of implied future volatility on the S&P500 -the so-called ‘fear gauge’- stands at 28, relatively high compared to the low-teens it stood at in January.
Reflecting its bias towards U.S tech stocks, the NASDAQ index is up an extraordinary 15% since 1st January. At the opposite end of the spectrum, the U.K market has a similar number to it, but with a minus sign in front, reflecting global investors ongoing caution towards financials and utilities, the U.K’s lack of large tech companies, and fears of a hard Brexit weighing on private sector investment spending and business confidence in general.
The prospect of very low U.S interest rates for a prolonged period of time, and signs of recovery in the global economy -particularly in Asia- has contributed to dollar weakness. Gold is rallying, as low dollar interest rates have reduced the opportunity cost of holding the metal. At $1,750 an ounce, it is snapping at the heels of the September 2011 peak of $1,896. Also stimulating interest in gold is a growing fear amongst some investors of inflation, given the large quantity of money that is being created by central banks.
How should investors respond? Andy Haldane, the Bank of England’s chief economist, said this week that the U.K economy is growing faster than the Bank forecasted as recently as May, and it now appears on track for a ‘V’ shaped economic recovery. With strong economic data coming from China, four million new jobs created in the U.S in June, and a strong rebound in retail sales in most developed economies in June, a similar point can be made about the global economy in general: the most severe downturn in the global economy in many decades may also be the shortest.
Of course, this sits uneasily with recent OECD and IMF economic forecasts, both of which suggest that the global economy will not return to its pre-crisis level of output until 2022, as unemployment and household debt curb consumer spending. But financial markets barely moved on these predictions, instead they have focused on the more up-to-date ‘real time’ economic data that drives Mr Haldane’s optimism, and the belief that central bank and government policies will remain supportive after economic recovery has begun.
The deVere view remains to favour a ‘U’ shape recovery for the global economy, rather than an accelerated ‘V’ shape. The global economy may make good its recent losses by the third quarter of 2021. If this scenario occurs, a rebound in corporate earnings will justify current share prices.
A multi-asset portfolio that contains equities, bonds and other asset classes is the best way of protecting savings from market volatility. This approach would also help avoid ‘country bias’, which is the habit we have of favouring stocks from our own country. Separately, we should perhaps also be taking a judicious view on our exposure to the U.S stock market, given that it dominates global stock market indices but that it may be entering a period of relative underperformance.
Is the U.S stock market overvalued? At the end of June the S&P500 was trading on forward P/E of 21.7. This was well above the 25 year average value. Other measures, such as price-to-book, price-to-cash flow, and the CAPE Shiller P/E, are also above their long term averages. Meanwhile, the MSCI All Countries World Index ex U.S (ACWI ex U.S) was on a forward P/E of 16.7. This is within its 25 year average range, and suggesting that after several months of outperformance from the U.S stock market, other markets may offer better value. Indeed, investors have begun to favour cyclically-sensitive stock markets in continental Europe and the emerging markets over the U.S.
Second waves, the presidential election and trade. In addition to fears of second waves of Covid-19 emerging in some states, Wall Street may soon be buffeted by political and trade talk-uncertainty. Historically, investors have been highly sensitive to both. The Democrat candidate Jo Biden leads Donald Trump in opinion polls (by 14 percentage points in a recent New York Times/ Siena poll). Should the Democrats win the White House, and both parts of Congress, it will be in a powerful position to bring in regulation affecting banks, healthcare, tech, energy and other sectors that it believes under-serve the American people in various ways. Share prices in these sectors may react negatively on the prospect of greater regulation.
Meanwhile, the Trump administration has stepped up criticism of its trading partners in his battle against global trade. A substantive trade deal with China, which covers difficult issues such as state aid for Chinese companies, and theft of corporate know-how, now looks unlikely given the growing list of grievances between the two countries. Last year’s ‘shallow’ trade deal risks unravelling.
Perhaps ironically, given Trump’s bombast against China, both Beijing and Moscow are thought to favour a Trump victory in the November presidential election. This is because Joe Biden is more likely to seek, build, and to benefit from a co-ordinated foreign policy response with western allies.
Meanwhile the U.S is looking to apply 100% tariffs on $7.5bn of E.U goods, including imports from the U.K, which it is entitled to do after the WTO ruled that Airbus has received illegal state aid from E.U member states. The E.U had requested that the U.S wait until a similar case that it brought against Boeing is ruled on by the WTO, this summer. It is thought that the E.U’s determination to tax American tech companies more effectively is what triggered the response from Washington.