Over the last week, we’ve had some spectacularly weak US employment figures – the weakest ever. The reporting season for corporate earnings continued its dismal pattern, earnings for the first quarter were bad, and the second quarter will be much worse. Forecasts for global growth continue to be cut and there are signs that forecasters are becoming less optimistic about the recovery.
Technology driving the rally, but for how long?
How have equity markets responded to all this? They’ve rallied. In the last five days almost every stock market is up by a few percentage points. In terms of year-to-date, China has been the best performer, but we are not confident in the accuracy of the numbers. Beyond China, it’s been the US that has been the star performer, notably the NASDAQ, which is now up year-to-date, with a rise of over 5% in the last week. The technology sector has outperformed to such a degree that market breadth has become very narrow; only a few stocks have rallied but they’ve rallied a lot. This is a worrying sign – bear markets are often preceded by a decline in market breadth.
Few investors are optimistic, even fewer anticipated the strength of the rally. It began as forced selling was replaced by semi-forced buying, notably rebalancing flows which were estimated at $2 trillion, which is a huge amount. I did think towards the end of March that the market would rally. I tentatively suggested 3000 for the S&P 500 as a reasonable year-end target, but I never expected it to nudge that level by the end of April.
Perspective is needed when using China as a blueprint for recovery
So what’s going on? You can certainly point to the turning tide in the virus numbers. Throughout Europe and in much of the US, the growth in new cases and fatalities is slowing. In New York and most European countries, the daily growth rates are down to 1% or less. All the talk is of easing the lockdowns. And we can look to China, which is a couple of months ahead of Europe and the US, where the economy is getting back to normal. Industrial production is limited only by weak external demand, construction is strong and car sales are buoyant.
But it is important to keep a sense of perspective. China had a very stringent lockdown, the Chinese population complied, and the lockdowns were eased only when new cases fell to very low levels. And although some sectors have recovered, many remain very subdued. Consumers are reluctant to use the subway, go to restaurants or hotels. It will be a slow road to recovery in China, and the risks of a second wave of infections are much higher in Europe and the US. 20 states in the US are exiting lockdown even as the White House has a cluster of virus cases.
Forecasts for economic growth and earnings still too high
Estimates for Q2 economic growth in the developed world are gradually being cut. At -5%, I think they are still too high. The same is true for earnings estimates. Q1 has come in at -14% for the S&P, but the estimate for Q2 is -40% and it’s dropping by 2% a day. I do think there is the risk that the market takes another step down. But I’m not sufficiently confident of that to sell the market at this point.