Friday, 19th of June 2020
“Trust dies but mistrust blossoms.”
This week the English Premier League kicked off once again after a 100-day lockdown hiatus. With little by way of social distancing on the pitch, and players shunning masks for their first day back in the office, fans caught a glimpse of what life was like before the coronavirus nightmare began. That said, the fake crowd noises that boomed out from the empty stands provided a rather eerie backdrop for the first post-covid-19 installment of the beautiful game. Still, the return of football is an important milestone on the road to re-opening society. And it coincided with a sharp recovery in asset prices after last week’s steep market reversal; although, to be fair, football was probably somewhere near the bottom of the list of causal factors. The S&P 500 Index was up +2.4% this week ahead of Friday’s open, despite worrying outbreaks in Florida, Texas, and California, and 16 states reporting a so-called ‘R-number’ >1. Across the Atlantic, the Stoxx 600 Index has also had a good week, up +2.6% by Thursday evening. The index has subsequently added >90bps to that return tally this morning, despite reports that two meatpacking factories in Germany and the UK are hotbeds of infection, given the damp, wet, cramped, and airless conditions that prevail there. In emerging markets, where the virus is still rampaging and national lockdowns (e.g., in India) have proved unsustainable, the MSCI EM Index is also up +0.8% (in USD) for the week (in advance of Friday trading). This rally comes despite quarantine measures returning to Beijing, where an increase in testing revealed a second wave of cases. In fixed income, meanwhile, spreads on US IG and HY bonds have narrowed 12bps and 34bps, respectively, over the first 4 days of the week as the risk-on mood lifted credit too.
The most important driver of this week’s equity and bond market moves was the Fed announcing that it would now begin to buy individual IG corporate bonds and so-called ‘fallen angels’ (i.e., IG bonds that have been re-rated HY since the onset of the crisis) rather than solely ETFs as it has done to date. This announcement did much to soothe the market after investors briefly deigned to focus on the economic ‘here and now’ last week. Indeed, after Fed Chairman Jerome Powell’s comments on Tuesday, the S&P 500 Index made a truly remarkable reversal. Previously, 80% of index constituents were in the red for the day. However, by the close of trading the percentages had flipped and just shy of 80% of S&P 500 stocks were positive. The change in direction was driven almost entirely by high-frequency and quant strategies responding to the generic news of ‘more stimulus’, since the Fed had – of course – already announced that IG bonds could be bought and even that the bank intended to do so. Digging beneath the headlines, it looks rather like the Fed wants to replace its ETF purchases with bond purchases rather than increase the aggregate volume of purchases substantially. Still, that suits us – with our IG bond holdings likely to benefit directly. Indirectly, the Fed action should support the whole fixed income universe – including EM debt and HY bonds – as they rally in sympathy with IG. The move upwards has proved self-sustaining so far, helped along by the Bank of England, which announced another £100bn of QE, and by rumors that the Trump Administration is mulling a $1tn infrastructure bill. Given the magnitude of the balance sheet stresses facing companies and households at present, the latest stimulus measures are unlikely to be the last. Particularly if strong US retail sales figures (+17.7% in May) are a flash in the pan.
The other big news this week came from Asia, where geopolitical tensions are mounting between India and China, as well as between North and South Korea. Since a brutal hand-to-hand skirmish left dozens of Indian and Chinese soldiers dead in a high mountain pass on the Kashmir border, both sides have been engaged in sabre-rattling while nationalist protestors have called for revenge. India and China are both nuclear powers and have the world’s two largest armies so an escalation of the conflict could have serious security consequences. The leadership of both countries are cognisant of this and appear eager to avoid military action. However, momentum can build of its own accord and this episode reveals the tensions that are building up in Asia as China’s rise disturbs the geopolitical status quo. Meanwhile, on the Korean peninsula, Kim Jung-Un and his sister Kim Yo Jung have adopted a new hard-line policy on the South, moving troops into parts of the de-militarised zone and blowing up the joint liaison office in the border town of Kaesong. It is likely that such hostile manoeuvres are about establishing escalation dominance and building leverage for future negotiations, rather than about the North preparing for war. But a lot could go wrong when tensions are frayed, and trust is so low.