Investment Outlook 5th June 2020
A fortnightly look at global financial markets by deVere Groups, Senior Investment Strategist Tom Elliott.
- Global stock market rally broadens as confidence builds
- Volatility continues to fall
- Wall Street vs Main Street debate perhaps misses the point
- Sterling to remain unloved?
Market sentiment: Confidence grows amongst investors of a strong economic recovery from the third quarter. Stock market sectors that had been lagging in the recovery rally, such as airlines, housebuilders and restaurant groups, have made strong gains in recent weeks. In other risk assets, spreads on corporate and EM debt continue to narrow, and recently Italian government bonds have also joined in the ‘risk off’ rally. Brent oil sits at $40 a barrel, double its late-April low.
The continued progress of risk assets reflects confidence the steady easing of lockdowns throughout most of the world in recent weeks, with -so far- only mild second waves of infections occurring. It also reflects further fiscal and monetary stimulus that has been announced in Europe, China and the U.S. Indeed, core government bond yields remain at near-March lows, in anticipation of negative interest rate policies being announced by more central banks, including the Bank of England. We recently saw the first ever negative prices achieved by U.K gilts at auction, when the government sold some three-year paper to investors willing to pay 0.05% interest for the privilege. At a time of ballooning government deficits everywhere, this is extraordinary, and reflects investor belief in very low interest rates across the global economy for some years ahead due to central bank policy.
The VIX index of implied volatility on the S&P500 (the so-called ‘fear-index’) is at 23, a far cry from the 83 it reached on 16th March when global financial markets were at peak-turmoil. The VIX started the year at 15.
Wall Street vs Main Street. There is currently a debate amongst investors and economists that is characterised by the tag ‘Wall Street vs Main Street’. Pro-risk investors, in this argument, are being egged on by Wall Street brokers to bid up equities and corporate bonds in defiance of the facts on the ground. These facts amount to assertions that the global economy may not recover in the U-shape scenario (as discussed in previous Investment Outlook editions), that investors are placing their hopes on.
For the worriers, a temporary unemployment problem may become permanent if we see widespread corporate insolvencies, which would also put stress on banks’ balance sheets and hinder fresh loan growth. The economic recovery period will, in any case, be muted by governments, households and businesses all seeking to pay off debt, meaning a rise in taxes and less discretionary spending by households and investment spending by companies. All of which will weaken aggregate demand in the economy.
The worriers point to the very low core government bond yields as proof of low growth expectations, in direct contradiction of the relative optimism expressed by stock markets.
No serious investor will deny the risks a period of debt-deflation, of a structural unemployment problem emerging from the crisis, and even another bank solvency crisis such as we saw in 2008. But these are alternative scenarios for most people, not base case scenarios. Given the extraordinary amount of fiscal and monetary policy support being offered by governments and central banks, including the Fed’s promise to ‘do whatever it takes’ to restore growth, a U-shaped global economic recovery, starting in the third quarter, still seems the most likely scenario. This would imply global GDP recovering the losses of the first half of 2020 by late 2021, and a sharp rebound in corporate earnings over the quarters to come.
It should also be noted that very low core government bond yields probably reflect massive central bank buying of government and corporate bonds, rather than investors’ views on growth. The asset purchase programs create huge distortions in bond prices, nullifying any claim that they are sending a market signal on growth and inflation expectations. Indeed, originally intended in 2008 to help bring down borrowing costs in the real economy, central banks asset purchase schemes (such as the ECB’s newly-expanded Eur 1.35 trillion PEPP) today resemble schemes to finance government deficits.
Brexit and sterling. No agreement was reached in this week’s round of talks between the U.K government and Brussels, over the U.K’s future trade relationship with the E.U. The E.U is disappointed that U.K prime minister Boris Johnson is not keeping to the commitment he gave in the non-binding political declaration, which accompanied the Withdrawal Agreement (W.A). In this he agreed that the U.K will seek an ‘ambitious, broad, deep and flexible partnership’ with the E.U. The U.K government is now seeking a minimalist approach on the current sticking points of fishing, ‘level playing field’ rules, and the role of the ECJ. Mr Johnson has also been reluctant to fully explain his government’s understanding of the Irish border protocol, which was attached to the W.A. The deadline for a trade agreement is ostensibly the end of June.
Sterling’s recent stability is likely to be tested, as the U.S and E.U see stronger economic recoveries than the U.K (as suggested by consensus forecasts from the Economist Intelligence Unit) and fear of a no-deal with the E.U rises.