Waving away grim economic tidings 

Another round of abject economic data has prompted a collective equity market shrug in Europe and the US. Plenty of bad news is expected and market sentiment is focused more on an eventual rebound in activity rather than reacting sharply to current economic pain.

Cue, further gains for Wall Street, led by Amazon and Netflix hitting record highs, after US weekly jobless claims rose 5.25m for a cumulative rise of 22m over the past month. Over the past decade, the US economy generated 22.8m jobs, so within a month, the coronavirus pandemic has erased all the gains of the previous business cycle. 

Once the economy starts opening up, the pace of hiring may well eclipse the trend seen in the wake of prior recessions, or at least that is the hope and one that helps sustain risk assets well above last month’s nadir. The danger is that companies remain cautious, particularly amid a slow restoration of activity and pronounced changes in consumer behaviour as social distancing becomes entrenched. 

Oxford Economics believes:

“While some jobs will be recouped as activity rebounds, we don’t expect the economy to reach the February 2020 level of employment until early 2022.”

For now, all of us are in wait-and-see mode, with market sentiment clearly tilting towards signs of recovery during the second half of the year.

Analysts at JPMorgan believe:

“Investors are increasingly discounting the Covid-19 hit to fundamentals this year and turning their gaze to 2021 recovery. We maintain a positive view on US equities given faster than expected progress in governments containing the virus spread, unprecedented monetary and fiscal response, and very favourable investor positioning.”

A more testing time arises for market sentiment, should incoming data show deeper stress and cast doubt on the strength of an expected macro bounce later this summer. Pressure on shares for banks and credit card providers suggests not all investors are not quite convinced that the worst is behind them.

Seema Shah at Principal Global Investors cautions:

“Concerns for the second half of the year may be underestimated. Although governments are looking to lift lockdowns, the re-opening of economies will be only gradual, compounding financial strains for businesses and households, suppressing demand and suggesting a slower economic recovery.”

An elongated pace of recovery in the underlying economy will ripple through the equity market. Dhaval Joshi at BCA Research highlights one important aspect about global equities:

“Today, just as in 2008, sales per share have become overstretched relative to GDP, so there will be a catch down.”

Dhaval still expects equities are “likely to produce annualised nominal returns in the mid-single digits, comfortably higher than the yields on long-term government bonds”. But there is a caveat should the long-term consequences of the pandemic knock the “multi-decade uptrend in stock market sales and profits” and Dhaval says:

“The long-term threat comes from the pandemic’s after-effects on economic and political systems — such as crippled banking systems or large-scale nationalisations of the private sector.”

Quick Hits — What’s on the markets radar?

The push for a eurozone pandemic fund is being driven by France, with President Emmanuel Macron telling the FT there is “no choice” but to set up a fund that “could issue common debt with a common guarantee” and prevent a populist backlash in Italy and Spain. 

New record highs for Amazon and Netflix on Thursday highlight the narrow band of winners that are driving Wall Street at the moment. 

David Jane at Premier Miton, the asset manager says:

“At the present time the obvious call most investors seem to be making is that the US is best placed to recover from the crisis, particularly given its heavy weight towards big monopolistic growth businesses, and this is seen in current US equity outperformance.”

Shares in Netflix are higher by nearly 40 per cent so far this year, and Amazon has gained about 30 per cent. 

Another winner of note is gold, above $1,700 an ounce and not far from record territory at $1,900. Ole Hansen at Saxo Bank says negative real yields are an important driver (as shown in the chart below):

“The level of stimulus currently going into the global economy is likely to support gold over the coming years with yield curve controls likely to push real yields deeper into negative territory.”

In the near-term, Ole adds:

“Short-term tactical short sellers have no reason to attack the metal as long as it holds onto $1700/oz. Failure to do so could see it retrace lower towards $1680/oz or worst case, in our opinion, $1640/oz.”

Expect buyers of such a dip as central bank balance sheets expand further from here. 

The rapid rise in government spending understandably arouses expectations of an inflationary leap along with higher bond yields in the coming years. 

Chris Brightman at Research Affiliates says the worry rests with Congress rather than the Federal Reserve:

“With the economy at full employment, $1tn deficits didn’t cause inflation in 2019. If a tripling of those trillion-dollar deficits doesn’t cause inflation in 2020 and 2021, will Congress choose to raise taxes and/or reduce spending in 2022?”

Over at Pimco, Joachim Fels downplays the prospect of higher bond yields from a surge in government spending for two reasons. The first reflects “the private sector — both individuals and firms — is likely to want to save more for years to come” and “provide a powerful offset to higher public sector deficits”.

The other factor set to play a key role is that “central banks will likely keep short-term interest rates low and cap intermediate and longer-term bond yields via large-scale purchases and/or more direct forms of yield curve control”.

Joachim adds: 

“With debt-to-GDP ratios expected to be significantly higher after the pandemic passes, monetary policy will likely have an important role to play in helping governments cope with the debt in ways other than outright default or recessionary austerity.”

Source: Economy - ft.com