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Monthly Market Commentary - July 2020

Whilst equities have recovered impressively from their March lows, this year has been characterised by widely divergent regional stock market performance.

Jon Cunliffe

in Fiduciary news


Whilst equities have recovered impressively from their March lows, this year has been characterised by widely divergent regional stock market performance. This was driven by a combination of the impact of Covid-19 on relative economic growth – and the extent to which the principal central banks have been successful in creating asset-price reflation.

Mega-cap US technology and domestic Chinese equities have performed strongly, returning 21% and 16% in Sterling terms, with returns for European and UK equities still languishing in negative territory.  Early and aggressive US fiscal and monetary policy easing, with Covid-19 accelerating the digitisation of daily life, have been relative tailwinds for the Nasdaq. Elsewhere, an earlier cyclical recovery from lockdown – and domestic policy geared towards boosting asset prices – have been positive for the Chinese Shenzhen/Shanghai 300 Index. 

The Eurozone and UK economies have thus far been hardest hit by the effects of the virus – and the historically high-yielding FTSE 100 has also suffered due to the cancellations and cuts in dividends as corporates strive to bolster their balance sheets. Another factor holding back UK equities has been a less-aggressive policy response so far from the Bank of England in its bond buying, relative to the US Federal Reserve and European Central Bank. 

In stark contrast to the recent impressive recovery in equities from the dark days of March, economic data for the second quarter confirms that we have seen the biggest contraction in global activity since the Second World War. To illustrate, even the US, which has fared relatively well, has sustained a contraction in its economy approaching 10% of GDP.  Adding to this, and with corporate profits a leveraged form of GDP, it looks like second-quarter corporate earnings could fall roughly 30% year-over-year.

One way to reconcile all this bad news with the recovery in equities is by looking at high-frequency indicators of business activity, such as the Purchasing Managers’ Indices (PMIs). National PMIs around the globe collapsed at unprecedented speed during February, March and April, but swift and aggressive fiscal and monetary policy support – in conjunction with the easing of lockdown restrictions as the spread of Covid-19 was supressed – has unleashed considerable pent-up demand, causing a sharp bounce back in activity. This has encouraged market participants to look ahead to a further pick-up in growth and a substantial recovery in corporate profits beginning from Q3 this year.

As we look towards year end, the optimists would argue that record-low interest rates and central bank bond buying will continue to support the value of risk assets, particularly equities.  This is because low bond yields reduce the discount rate applied to future equity earnings and boosts the present value of those cashflows, resulting in higher price to earnings valuations. In addition, many would agree that we are likely to see an optically impressive bounce in growth and corporate earnings data over the rest of 2020.

However, with government deficits ballooning as a result of measures taken around the world to provide a safety net around large swathes of the economy, pessimists would contend that there is clearly less fiscal firepower now available to support economic activity should, as many people fear, we see a second wave of the pandemic. In this context, we would point out that there has been recent evidence of slowing activity in the US on the back of a spike in Covid-19 cases – and this calls into question the “V-shaped recovery” thesis which has been adopted by many market participants.

If you add to the mix the escalating tensions between the US and China on technology transfer and intellectual property rights, and a highly uncertain US Presidential election, it looks like we are going to remain in an uncertain and volatile market environment for some time to come.

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