By Kevin Miskin, Hottinger Investment Management
July offered a something for ‘glass half full’ and ‘glass half empty’ investors alike. Politics scored highly for those of a pessimistic disposition as tensions rose between the US and China. President Trump openly expressed his increasing anger with Beijing, which culminated in consulates being closed in both countries as part of a tit-for-tat spat. Matters could deteriorate further in August if the US government calls time on Microsoft’s acquisition of TikTok, having already accused it of being a conduit for Chinese state-sponsored spyware [i]. Meanwhile, Brexit negotiations rumbled on with seemingly little progress, particularly on how to ensure a “level playing field” and access to British fishing waters. In an effort to accelerate the stymied talks, Boris Johnson had called for the two sides to “put the tiger in the tank” — a throwback to the old Esso petrol adverts, but maybe Michel Barnier and his cohorts are driving BWM i3s and Renault Zoes, metaphorically speaking.
Brexit to one side, the EU’s 27 national leaders found fiscal unity, albeit after arguably the coalition’s longest ever summit, to agree the EUR750bn “Next Generation EU” (NGEU) fund to help countries recover from the Covid-19 recession. Most leaders could claim to have gained from the talks; the French and Germans saw their plan approved, the southern states should receive funds worth several points of GDP and the so-called “Frugal Four” countries of The Netherlands, Austria, Sweden and Denmark won concessions [ii]. Symbolically it was a historic moment, similar to that of Mario Draghi’s pledge to do “whatever it takes” to save the euro.
Understandably, the pandemic continued to influence the economic data. The US Federal Reserve (Fed), for the first time in its official statement acknowledged the virus would significantly influence the fate of the US economy [iii]. The closely watched weekly US unemployment claims, which had shown a consistent improvement since March, started to rise in the latter part of the month as the death toll started to rise again. The US also reported its largest contraction in post-war history as the economy shrunk by 9.5% during the second quarter. In Europe, where it is widely considered that the virus has been handled more effectively, the GDP reports were similarly stark. The German economy shrank by 10.1% in the second quarter, thereby wiping out ten years of growth according to Berenburg Bank, while France contracted by a record 13.8%.
In the UK, chancellor Rishi Sunak delivered a “summer economic update” in which he announced £30bn in new measures, equivalent to 1.4% of pre-crisis GDP, for the current financial year. His plans included a £2bn KickStart scheme to provide six-month work placements for the young unemployed, a much-needed cut in VAT for the leisure and hospitality industries and an “Eat Out to Help Out” scheme aimed at helping pubs and restaurants. By and large, commentators were underwhelmed. For example, Pantheon Macroeconomics believes that £30bn will be insufficient to “fill the void” when the furlough scheme ends in October. Yet, it was not all ‘doom and gloom’ as retail sales recovered far more strongly than forecast in June, according to the Office for National Statistics, and Bank of England Governor Andrew Bailey remarked that there were signs of activity returning “quite strongly” in the housing market and in new car sales [iv].
One area of the world that has returned to growth is China where GDP expanded by 3.2% in the second quarter, thereby providing the earliest signs of recovery from the fallout of the pandemic. Nevertheless, on balance the global economic backdrop remains challenging, not helped be emerging signs of a second wave towards the end of the month.
The US dollar, often viewed as a safe-haven currency, dropped more than 4% against a basket of other currencies to post its worst monthly performance in a decade. Several factors are weighing on the ‘greenback’ including outbreaks of the virus in key states (including, California, Texas and Florida) and the upcoming election where Democratic candidate Joe Biden has a commanding lead in the polls. In addition, the euro has gained traction because of the recovery fund mentioned above and other parts of the world are showing nascent signs of recovery. Does all this mean the dollar is under threat as a reserve currency? We suspect not just yet, as it was only four months ago that investors flocked to the dollar for safety.
Meanwhile gold, referred to the currency of last resort recently by Goldman Sachs, gained more than 10% to reach an all-time high. The combination of lower real yields and a softer dollar has provided the perfect backdrop for a major rally in the yellow metal. Some investors are also purchasing gold as an inflation hedge, taking the view that at some point global economies will recover from the pandemic and central banks will allow prices to rise to reduce their debt burden. Nevertheless, talk of inflation was lost in government bond markets as concerns regarding growth resulted in even lower yields; the US 10-year yield edging lower to 0.53% and the benchmark UK gilt yield falling to 0.10%.
With risk-off assets in the ascendancy, it was somewhat unusual that risk-on assets also recorded healthy returns in July. US junk bonds had their best month in nearly nine years as the average yield fell below 6% [v], despite the number of defaults in H1 having exceeded the total for the whole of 2019, according to Moody’s. Further, Moody’s expects the default rate to almost double from current levels, before peaking at 9.6% in Q1 2021, with bankruptcies likely to be concentrated in the Retail, Oil & Gas and Leisure sectors.
Global equity markets appreciated by 4.7% buoyed by a positive US earnings season and nascent signs of a recovery in M&A activity. Yet, a deeper delve into geographic and sector returns revealed a more mixed picture. China (+12.8%) and the US (+5.5%) led the way while Europe (-1.8%), Japan (-4.0%) and the UK (-4.4%) posted losses. The Chinese market enjoyed strong gains after a widely read, state sponsored securities journal told investors to expect a “healthy bull market”. Investors also reacted positively to news that the benchmark Shanghai Composite index is to be rebalanced with a greater bias towards technology stocks.
Reporting season started in earnest for S&P500 companies. The bar was set low with aggregate earnings expected to decline by 44%. Yet, with 60% of companies having already reported, earnings have exceeded forecasts by 23% and Q2 is on track to record the largest earnings surprise since FactSet records began in 2008 [vi]. Technology and consumer discretionary stocks dominated the positive reports as the main beneficiaries of the surge in online consumption and service provision. In addition, a study by Credit Suisse conducted during earnings season concluded that some of the largest US multinationals have continued to buy back shares despite expectations to the contrary following the pandemic, thereby adding a further support to the US market.
Once again, the UK was one of the worst performing markets, dragged down by the Banking, Oil & Gas and Telecom sectors which suffered from disappointing company earnings. Of note, Royal Dutch Shell reported an 82% decline in net income while Lloyds Bank, considered to be a UK bellwether, adopted a more pessimistic stance on the UK economy than when it reported three months ago.
[i] bbc.co.uk – TikTok: What is the app and how much data does it collect?; August 3, 2020
[ii] The Economist – The EU’s leaders have agreed on a €750bn covid-19 recovery package; July 21, 2020
[iii] ft.com – Fed warns resurgence of virus threatens economic recovery; July 29, 2020
[iv] Barclays Bank – Morning Briefing; July 20, 2020
[v] ft.com – US junk bonds notch up best month since 2011; August 1, 2020
[vi] FactSet – S&P500 Earning Season Update; July 31, 2020
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