i-Wire: Market Update 13th May

Market Update: The Ghosts of Markets Past

We are still a very long way from clarity as to the long-term consequences of the pandemic as this dreadful virus continues to totally dominate the news flow, and of course our lives too.  After some thoughts on the current and seemingly contradictory messages the markets are sending, I’ll turn instead to what they aren’t thinking about now but could well do so in the coming months once they begin to look beyond the pandemic (clue is in the title!).

Markets

As usual, I’ve included a chart that shows the returns from markets in their own currency and a table which shows the sector fund average return which for overseas sectors includes the translation back into sterling. As the pound has been weak this year this enhances returns from overseas markets making the US even more of a winner, and the poor old UK look even more of a loser.

Figures from Financial Express Analytics

I thought I’d also introduce a table, with data courtesy of the JPM Asset Management Weekly Brief, which shows the winners and losers in terms of industrial sector and style:Figures from Financial Express Analytics
Figures from Financial Express Analytics

The winners are the sectors with the large resilient companies that can still produce growing revenues and profits in an environment of super-low interest rates, recession and a very different looking global economy.

Market Outlook: Not such a V shape after all

If the stock market is a discounting mechanism, what exactly is it telling us? The obvious answer is that having crashed horribly and then bounced strongly it is saying that the recovery in global growth is going to be V-shaped. Looking at the indices as single indicators then this appears correct but looking inside the market at individual stocks and sectors tells a different story. The markets continue to be led by a narrow band of the consistent growth sectors, not the cyclicals, industrials and financials which typically lead a ‘economic growth is rebounding strongly’ market. Other asset classes have the same narrative. The Bond market is telling us we are in for tough times ahead with government bond yields on the floor and credit spreads still wide. Base metal commodities, notably copper, are signalling muted recovery whilst gold, a classic ‘risk off’ asset has been strong.

This is both re-assuring and disturbing. Re-assuring to an extent that it shows the equity market isn’t believing in a swift V-shaped recovery and so won’t be too disappointed when subsequent data shows that we are in for a much longer haul. Disturbing because it shows that the equity markets have rebounded not so much because they are optimistic about the future but because of a wave of liquidity from Central Banks which in effect doubles up the bet of the last decade and questions ‘what happens when central banks can do no more’. And the niggling doubt in my mind? The market may not necessarily be pricing in a V shaped recovery but nor is it pricing in a significant second wave of post-lockdown infections which, whatever the munificence of the central Banks, will likely lead to renewed falls.

Those Ghosts…

This is a ‘one issue’ market, solely concerned with the spread of the pandemic and the shape and magnitude of the eventual economic recovery. Markets are largely ignoring the issues that had dominated sentiment for the previous decade; Eurozone dysfunction, Brexit and the US/China trade war. These skeletons have not gone away, they remain hiding in the cupboard, the pandemic serving only to magnify not heal the rifts.

Europe

Europe was not well placed going into the pandemic. The economy was on the verge of recession, Brexit leaves a huge hole in the Eurozone budget and the rich north/poor south divide was as wide as ever. The pandemic has shown only weakness not strength; if a union cannot pull together in a crisis, when can it? The Eurozone countries turned in on themselves in the face of the pandemic and, as individual countries, set their own restrictions and border controls. Financially it has also been a case of every man for himself which will only widen the rifts apparent in the rolling Eurozone crises of the last decade. What differentiates the Eurozone from the US and the UK is that it can’t produce a quick and effective fiscal package because it doesn’t have a common fiscal policy. President Macron, to his credit, is playing the unity card saying ‘Europe has no future if we cannot find a response to this exceptional shock’ but his words are falling on stony ground. There was an attempt to issue ‘Coronabonds’ (joint debt for which all Eurozone members are liable) but Germany not surprisingly was not too keen; ‘debt mutualisation’ is not a popular word in Frankfurt, nor in Amsterdam and Stockholm.

Monetary policy is increasingly problematic leaving Italy as the prime candidate for being the first casualty. Its high indebtedness (135% government debt-to-GDP ratio and rising) and lack of economic growth require rescue policies that are either theoretically illegal in the eurozone, or politically unpalatable in Italy with political parties already talking of defaulting.  The ECB has launched a number of rescue package that in a rather ambiguous way would  buy shed loads of Italian government bonds but that in itself is politically fraught with Germany’s constitutional court ruling that the ECB has breached its mandate and strayed into broad economic policymaking and as such has no validity in Germany. Even if these cracks are papered over, Italy is not Greece and Portugal, it is too large to be bailed out and if bond markets once again begin doubting its solvency this would have grave repercussions for the future of the euro and the EU itself.

As for Brexit…

The Brexit transitional arrangements expire on December 31^stwith any extension needing to be agreed by June 30^th which in his normal cavalier way pre-Covid was something Boris said we would never ask for. If ever there was a ‘force majeure’ reason to extend a deadline it is now. Apparently not, the UK has just begun separate trade negotiations with the US (good luck with that) and December 31^st remains as a cliff-edge. Politics, politics of course and you will have your own views. The ‘Remainers’ (to use that quaint phrase from the past) will say that Boris is nothing if not an opportunist and now has a golden opportunity to hide the economic pain from Brexit inside the far larger fall-out from the pandemic. Convenient. The contrary view is now that the German constitutional court has blocked the ability of the ECB to bail out Italy indefinitely then the EU will have to switch to a fiscal bailout and if we’re still in transition then we’re still on the hook to pay for this, throwing billions of good money after bad. The quicker we are out the better.  I’ll leave you to debate that over your dinner tables and Zooms.

Trade Wars Round 2

The ongoing trade war between the US and China had benighted markets for the last couple of years and there was a huge sigh of relief when, for their mutual political advantage, Trump and Xi cobbled together a truce for 2020. The pandemic threatens to rip this to shreds once some sort of normality is resumed. Any sympathy for China as ‘first in’ to the pandemic has long since disappeared with many in the US and elsewhere blaming China for the genesis of the virus given its ‘wet’ food markets and propensity for eating the exotica of the animal world. Further ire centres on initial Chinese denials, misinformation and failure to cooperate with international health agencies.

The long-term benign geopolitical game plan prior to the pandemic had been that China would gradually accept more democratic norms and embrace relations with the international community whilst at the same time selling the rest of the world a load of cheap kit.  Globalisation, win, win. Even pre-Covid this was already looking ragged, China was increasingly being seen as an increasingly autocratic state, solely self- interested, employing industrial espionage, stealing intellectual property and breaking agreed trade rules with impunity luring the gullible to become increasingly dependent on cheap Chinese goods and services. Huawei 5G being Exhibit A in the UK. Post Covid the China hawks in Washington will be gearing up for a field day. The Trump narrative is to always blame everybody but himself for any of Americas ills, and as criticism of his handling of the pandemic intensifies do you think Trump is going to miss the chance of China bashing on a huge scale as America gears up for the presidential election. No, neither do I.

Conclusion: Navigating the Uncertainty

People dislike uncertainty. They like a bit of structure and control, the ability to plan for the everyday, to take pleasure in anticipating treats and holidays and, if necessary, as a bulwark and comfort for the difficult times we all face occasionally. The pandemic has changed all this, we are having to embrace almost total uncertainty in everything we had previously taken for granted. Left field is now centre field.

The financial markets are absolutely the same, they crave certainty at the best of times, and these are the worst. They are positioning that the pandemic is under control and that economic recovery will be wildly different across different industries but in aggregate that there is light at the end of this darkest of tunnels. As a base case this is plausible and as good a guesstimate as any but with so much uncertainty and risk as the number of possible outcomes are mind-boggling. Amidst all this uncertainty we have sought to improve the quality and resilience of our underlying funds and increase exposure to the trends we think will drive ‘the new normal’ forward.

As always in these increasingly difficult times, everyone at HFMC Wealth continues to wish you and your families the sincerest of good health.