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May 2020 – Market Update

May was a month where cyclical assets outperformed on the back of the positive narrative around the easing of Covid-19 lockdown restrictions.

image of man holding an ipad with illustrative charts

Jon Cunliffe

in Fiduciary news


May was a month where cyclical assets outperformed on the back of the positive narrative around the easing of Covid-19 lockdown restrictions.  So far, the only countries where we have seen a meaningful easing have been Japan, Korea and Germany, and the overall constraints around free movement in the G20 remain significant. However, the markets are looking ahead to further progress along the path to a more normal social and economic environment. 

Within equity markets, we saw a strong performance from sectors which had previously borne the brunt of the measures initiated to contain the spread of Coronavirus – with consumer discretionary, industrials and energy companies outperforming and more defensive sectors such as consumer staples, pharmaceuticals and utilities lagging.  Elsewhere, technology continues to benefit from the secular trend of the increasing digitisation of daily life, which has had added impetus reflecting the much-increased need for remote working. 

With business cycle indicators pointing to improving levels of activity after the precipitous drop in March and April, commodity markets have also rallied.  It should be noted, however, that whilst the rate of change of recent indicators looks broadly constructive the absolute levels of activity are still very depressed. After a 5% annualised decline in growth in the first quarter, US GDP in the second quarter could fall by an annualised 40%, before making a partial recovery in the second half with output ending the year roughly 5% lower than pre-pandemic levels. This is more than twice the magnitude of decline witnessed in the 2008/9 financial crisis.  Looking further ahead, it is unlikely that global activity levels will return to pre-pandemic levels until towards the end of 2021, with corporate profits (which are essentially leveraged GDP) following a similar path.

If the macro backdrop is unhelpful, fiscal and monetary policy have provided offsetting support.  Direct government support for workers and the corporate sector more broadly have reduced the negative impact of lockdown measures on the consumer and, for the time being, have staved off a damaging wave of defaults.  Elsewhere, the Federal Reserve’s aggressive quantitative easing programme and a commitment to support the corporate bond market have reduced bond yields, narrowed credit spreads and eased financial conditions more broadly.  Indeed, much of the rally in risk assets reflects the view that central banks, in particular the Federal Reserve, have effectively “written a put option” underneath the market.

Whilst there is clearly some merit in the argument that equities are unlikely to fall below the March lows, market participants may be in danger of overestimating how rapidly global economy may return to a more normal environment and that the damage to large swathes of the corporate sector may be long lasting or even permanent.  

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