Friday, 5th of June 2020
“An ‘unemployed’ existence is a worse negation of life than death itself.”
– Jose Ortega y Gasset
Markets have continued to roar higher this week, despite the dire economic backdrop, a poisoning of US-China relations over Xinjiang, the coronavirus, and Hong Kong (which could yet collapse the Phase One deal), and the massive protests rocking America. The S&P 500 Index has smashed through 3100 and is now up +2.2% for the week ahead of the Friday market open. For Europe, returns this month so far have been even more impressive, with the STOXX 600 up +4.5% in the first four days. Moreover, on Friday morning, the index has added >1% to this tally. Despite the wins for developed markets, their emerging counterparts are nonetheless in pole position for the week and the MSCI EM Index is up a whopping +6.3% (in USD) as of Friday morning. The virus be damned.
As we discussed last week, the equity market rally since mid-May has been accompanied by a rotation away from high growth sectors, such as technology, into so-called ‘traditional value’ and cyclical sectors like financials, industrials, and energy. This is indicative of a shift higher in the market’s conviction about the durability of this rally, as investors ditch cash and pile into stocks that have failed to take part in the recovery so far. Indeed, airlines and other coronavirus-impacted sectors have seen some of the biggest gains in recent weeks despite many questions remaining about their long-term viability. And the rotation has affected whole regions and countries too. Europe is finally making up some of the ground lost to the US since the market bottom in March, while Brazil – which is an energy-dependent epicentre of the virus – has seen its benchmark BOVESPA Index rise a staggering +14.5% (in USD) since the start of June. The BOVESPA also saw gains of +8.9% last week and +10.8% the week before and is now up +38.1% (in USD) in just 20 days. Moreover, the strong performance is not restricted to equity markets. Corporate bonds have also surged higher this week, with yields falling across the quality spectrum. As of Friday morning, US HY spreads stand at 568bps over LIBOR, down 69bps month-to-date, while US IG spreads have also narrowed 19bps since the start of the month.
The huge global monetary and fiscal stimulus since March clearly bears the lion’s share of responsibility for this extraordinary cross-asset rally. And more support is on its way soon. Despite protestations by the German Constitutional Court, which questioned the legality of the ECB’s QE programme (i.e., the Pandemic Emergency Purchase Programme) last month, the central bank announced this week that they will now be increasing purchases by a further €600bn (bringing total purchases to €1.35tn). They will also extend the programme to June 2021 and will reinvest the proceeds from maturing investments until at least the end of 2022. Meanwhile, both the UK and US have declared this week that more fiscal measures will be coming this summer (in case there was any doubt). This will have a significant effect on risk assets, and it is highly unlikely to mark the end of the stimulus response.
To be sure, the opening up of Europe, America, and China have gone better than many feared (at least so far). And, just this week, China printed a service sector PMI of 55.0 (vs. 47.3 expected and 44.4 last month), which is the highest level since October 2010. This data bodes well for the rest of the world too, which remains several steps behind the Middle Kingdom on the road back to quasi-normality. However, the trashing of the global economy since February will inevitably bear a considerable cost to corporates and consumers this year. Markets closing in on record highs is not the backdrop that should accompany such a dire economic picture if cash flows were all that mattered to investors. Luckily for those who stayed invested through the crisis, liquidity matters too – a lot.
Undeniably, this rally is an artifice created by central banks and governments terrified of what a high cost of capital would mean for any nation in which large swathes of the economy have disappeared overnight. It can hardly be a coincidence that the outpouring of rage and grief over the tragic death of George Floyd is taking place in a week when payrolls are likely to show US unemployment climbing to ~20%. Even if the unemployment print falls well short of the big 2-0, it is certainly still at the highest level recorded since the 1930s. Most of those who have lost their jobs during the crisis will eventually return to work, but a political shake-up seems increasingly likely come November.