Signs of more second waves: will the markets sink or swim?
It’s been a tough time in the markets since last week’s update, especially for sterling-based investors. Most equity markets are lower, and the dollar has been weak so the return from world equities in sterling terms has been -2%. There has been no respite in domestic markets, as most of the earnings for FTSE companies are in dollars, so these markets fell by towards 3% over the week.
All this at a time of huge uncertainty over the US budget, trade tensions, signs of a second wave of virus infections in Europe as well and the US ‘sun belt’ states, and all deep in the midst of the reporting season for the second quarter, reflecting when the global recession was at its worst.
Data still coming in stronger than expected
Let’s begin with the virus, second waves and the impact on the world economy. Despite all the doom and gloom, the economic data shows that we’re recovering. The downturn was dramatically swift, but the recovery has also been rapid; more rapid than most forecasters expected. Data is still coming in much stronger than expected – and by record amounts. We are still well short of pre-Covid levels of economic activity, but the gap is now small in China where the virus first struck, despite the recent floods.
US recovery lagging, but only temporarily
Last week’s Purchasing Managers’ Indices (PMI) surveys were especially strong in Europe and the UK. Much stronger than in the US where the second wave in the sun belt is blunting the recovery. I covered the US second wave in last week’s update and suggested that the impact would be temporary, and delay their recovery for only two or three months. The recent evidence supports that view, with a notably improvement in hospitalisations in Florida meaning that alongside California and Texas – the 3 most populous states in the US, the tide is turning.
Europe’s economic data is ahead, but the strong currency has hurt equities
So, there’s mounting evidence that Europe’s better performance on the virus is translating into better performance for the economy. But as I’ve said before, the currency has taken the benefit so that equities in local currency terms have struggled. Europe’s outperformance is despite the mini second wave in Spain that has led the British government to suddenly change its travel advice for our favourite holiday destination. In most countries, including the UK, there has been only a modest rise in new cases since lockdowns were eased, with localised outbreaks being dealt with swiftly.
Time running out for new US fiscal package
There’s another big reason to be nervous about the US. Politicians in Washington are still arguing over the fiscal package to replace the massive support currently in place, including the generous $600-a-week paid by the Federal government to the unemployed. A deal has to be struck before the long summer recess which begins on 8 August. We think they’ll come up with a plan worth around $1.5 trillion, with the $600-a-week payment cut to $300. But they are still arguing over the aid to state and local governments, and it is already too late to avoid some losing all the unemployment supplement, even if this proves to be temporary. We believe they will reach an agreement over the next 10 days and it will give further support to consumers who have, in aggregate, seen their incomes rise in this most extraordinary recession.
Cautious, but conditions support risk assets
We’ve had another flood of companies reporting their earnings and they continue to beat depressed expectations in record numbers. I think earnings forecasts for the year are set to rise globally. And the yield on 10-year US inflation protected securities, a measure of the risk-free return, the fell to a record low of -94 basis points on Friday. That’s a big support for risk assets. So that’s why we still predict that equities will outperform.