By Kevin Miskin, Hottinger Investment Management
The rally in global stock markets showed no sign of abating in the early part of June as countries started to emerge from lockdown, further stimulus packages were announced and the economic data supported the view that there would be a ‘V-shaped’ recovery from the pandemic.
In Europe, Angela Merkel’s coalition negotiated a larger-than-expected €130 billion stimulus package that will provide an immediate boost to the economy through a relaxation of value-added-tax while France introduced a broader €45 billion stimulus plan [i]. Meanwhile, the European Central Bank (ECB) dispelled any doubts over whether it would act as lender of last resort by announcing an expansion of its bond-buying programme by a further €600bn [ii]. This latest action has taken the combined balance sheets of the eurozone, US, Japan, UK and China to more than $23 trillion from just $5 trillion in 2007, according to Haver Analytics.
The economic data from early June was similarly supportive. US and Chinese Purchasing Managers Indices, which measure the prevailing direction of economic trends, continued to improve, while Chinese new orders increased at the fastest pace in a decade. Yet, the data that caught investors most by surprise, and caused the US President to declare the recovery a “rocket ship”, were the US jobs numbers. The report showed 2.5 million jobs had been created in May with the unemployment rate having fallen to 13.3%, versus an expected rise to 20%[iii].
The market reaction to this bout of upbeat news was emphatic; the S&P500 index completed its best 50-day run in history (according to Barclays) having risen by more than 40% since the March lows. Meanwhile, longer-dated US Treasuries sold off; the yield on the US 10-year rose to 0.90%, its high level since mid-March, while the gap between the 5 and 30 year part of the yield curve widened to its steepest in almost three years.
Yet, the surprisingly good US unemployment report marked a peak for both US and global equities, not least because a closer inspection of the US jobs numbers revealed the rebound in hiring had been flattered by the structure of the US federal aid programme while permanent lay-offs rose by nearly 300,000 [iii].
At about the same time, the World Bank and US Federal Reserve (Fed) provided a more sobering view of matters which brought President Trump’s “rocket ship” recovery and risk assets back towards earth. The former said the global economy would contract by 5.2% this year, marking the fourth-deepest recession since 1900. Developed countries economies were predicted to contract by 7% on average, with emerging nations’ set to fall for the first time in at least six decades [iv]. Meanwhile, the Fed estimated that by 2022, the US would still have an unemployment rate of 5.5%, far higher than the pre-Covid level, with core inflation still below its 2% target level.
It also held interest rates at 0-0.25% by unanimous vote and pledged to continue buying Treasuries and mortgage-backed bonds at least at the current rate. Fed chair Jay Powell added “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates”. However, the US central bank did admit to considering “yield curve control” a more arcane approach dating back to the 1930s involving targeting interest rates along the yield curve.
The timing of the Fed’s downbeat economic outlook was unfortunate as it coincided with fresh concerns that a new wave of Covid infections was emerging in parts of the US, China and Europe, thereby amplifying the fall in risk assets.
For its part, the Bank of England maintained the Base Rate at 0.1% and announced that it would inject an additional £100 billion into the UK economy but at a reduced pace [v]. Governor Andrew Bailey explained the UK and global economies were healthier than the bank had expected, hence the reduction in pace, but the Bank felt more quantitative easing was necessary because the medium-term outlook was more troubling, especially for the labour market. Pantheon Economics echoed Andrew Bailey’s caution and warned that whilst the headline unemployment rate remained steady in April, the slump in vacancies pointed to a second wave of redundancies in the autumn as the furlough scheme comes to an end.
Four years on from the Brexit vote and there appeared to be encouraging signs that both sides were working towards a potential compromise. However, June ended with continued disputes over state aid rules and Michel Barnier rejecting the UK’s latest proposal regarding how financial firms conduct business after Brexit. The end of June also marked the deadline by which the UK could have requested an extension to the transition period with the EU.
In terms of markets, the near-term concerns over a second wave of the virus combined with dour medium-term outlooks from central bankers did not prevent equites from building on their recent gains, albeit at a slower pace. The MSCI World Equity Index posted a gain of 2.5%, led by the Hong Kong and Chinese markets which rebounded strongly from the politically induced sell-off at the end of May. Elsewhere, the FTSE All-Share index gained 1.4% while European stocks comfortably outperformed their US peers (+6.0% versus +1.8%, respectively). US equities have outperformed strongly during the past ten years but a number of factors are starting to favour European markets, partly as a result of Covid. The European response to the crisis has been more decisive and could enable the region to open its economies more quickly than the US. The Covid recession could also be the catalyst for a recovery fund that could provide greater fiscal flexibility than before. Meanwhile, the US is experiencing a rise in new infections with some states including California having to retrench rather than re-open their economies. US valuations are also expensive, trading at a 45-year relative high premium of 1.6 times to global markets [vi].
US, UK and German government bond yields continued to trade within their three-months ranges, peaking early in June before retracing towards their lows, to the end of the month broadly unchanged and thereby maintaining their hedging qualities versus equities.
In commodity markets, gold appreciated by a further 2.9% to take its gain for this year to 17.4%.
Corporate bond purchases by the Fed and ECB directly injected liquidity into higher rated companies but also supported the high yield sector as investors searched further down the ratings curve for yield. Ultimately though, we remain cautious on low rated companies (single-B rated and below), despite signs that the default cycle might be more subdued than initially feared. During the month, we added to global corporate bonds through a fund which invests in medium duration investment grade names, thereby a picking-up yield over government bonds for limited risk.
[i] Bloomberg – Merkel Seals Stimulus to Lift Battered Economy; June 3, 2020 [ii] FT.com – Eurozone bond prices jump after ECB move; June 4, 2020 [iii] The Economist – American unemployment falls, but normality is still far away; June 5, 2020 [iv] The Economist – Business this week; June 11, 2020 [v] FT.com – Bank of England boosts bond-buying by £100bn but slows the pace; June 18, 2020 [vi] Absolute Strategy Research – Weekly Wrap; June 12, 2020