In this week’s market update: May brings a new note of caution; and the medical crisis eases but economic news is still grim.
The end of one month and the start of the next should be irrelevant to investors. But the transition from April to May brought a major mood shift in the markets. Overnight the optimism that had buoyed shares since markets bottomed in late March disappeared to be replaced with a greater sense of realism about economic prospects.
Partly this was a natural reaction to a rally which had seen shares claw back around half of the losses they had experienced between February and March. Rising share prices, coupled with falling earnings estimates, had seen valuation multiples return to the levels reached when markets peaked at the start of the year. Investors were finding it harder to justify paying up on the basis of hope for a V-shaped economic and market recovery.
Sentiment was also hit by a deterioration in the rhetoric between Washington and Beijing over the initial cause of the coronavirus outbreak, with the US claiming that the virus had started life in a Chinese lab, apparently without any scientific evidence to back the assertion.
The prospect of renewed trade friction hitting already weakened economies caused investors to re-think the price they were prepared to pay for investments.
The economic data is starting to justify a more cautious approach. Essentially backward-looking, the numbers are beginning to catch up with the evidence on the ground. So, for example, Hong Kong announced its fastest ever fall in first quarter GDP, almost 9% year on year and more than 5% down on the previous quarter.
Manufacturing growth in India hit a record low, and the data in Taiwan and South Korea is weak too. In Europe, the latest round of purchasing managers’ indices for manufacturing hit historic lows in Italy and Spain. The ECB is now forecasting a sharp decline in Eurozone GDP in 2020, falling inflation and unemployment approaching 10%. Here in the UK, car sales slumped by 97% in April.
The confidence in a rapid recovery after what everyone knew would be a testing second quarter is now waning, with particular focus on a likely second wave of redundancies once the short-term fix of government payments to furloughed workers runs out. The terms on which countries move to re-open their economies suggest that some businesses may struggle even once a tentative return to normality is implemented and they may be faced with no option but to lay workers off at that point.
The suggested pattern of re-opening in the UK, due to be confirmed later this week, points to social distancing requirements which will make it difficult for many service sector businesses such as restaurants and bars to restart activity.
Office workers meanwhile face a prolonged period of working from home with knock-on impacts on ancillary businesses like sandwich shops and transport operators. With job losses announced or threatened at companies like Boeing, British Airways and Ryanair, it is clear that some sectors are already accepting that there will be no return in the short or medium term to the status quo ante. This is certainly the view taken by Warren Buffett, who this week said he had ditched all his investments in the airline industry.
The focus on the extended economic scars from Covid-19 comes even as the medical crisis seems to be abating. New cases have declined for a fifth day running worldwide, with some notable success stories such as Germany where daily deaths have now fallen to the tens rather than hundreds. New York state this week announced its lowest daily death toll since the end of March.
The better medical news, coupled with easing fears on oil storage provided some temporary relief for investors overnight, with Asian markets last night picking up on Wall Street’s modest 0.4% rise on Monday to post gains in Hong Kong and Australia. Markets in Japan, South Korea and China were closed for holidays.
One aspect of the medical story that is likely to have an important economic impact is a growing regionalisation of the exit from lockdown. France, for example, confirmed that it will not impose a 14-day quarantine on travellers from the EU, Schengen zone or UK. New Zealand and Australia are discussing a travel bubble between the two countries, while China and South Korea are negotiating free travel for business people from the two countries.
A key question as countries emerge from lockdown is the extent to which the economic slowdown moves from being supply to demand driven. To begin with economies shut down because factories, shops and offices were ordered to close. Moving forward, the limiting factor may be the unwillingness of workers and consumers to put themselves at risk after a period in which they realised that they had managed without areas of their lives which seemed a given - commuting, going to the gym, non-essential shopping etc.
The second constraint on the demand side of the economy, of course, will be rising unemployment. In the US, the jobless total has increased by 30 million over six weeks. This Friday, we will get an indication of the health of the US employment situation when monthly non-farm payroll data is unveiled. It is likely to provide a sombre end to the trading week, albeit one that the UK will be watching from the sidelines thanks to the May bank holiday which was moved to coincide with the commemoration of the 75th anniversary of VE Day, the end of the war in Europe in 1945.
The fragile state of the economy means that central bank and government policy will remain front of mind for investors. This week sees the Bank of England bring up the tail of a series of central bank meetings over the past couple of weeks. As with the announcements in the US and Europe, less is expected now that the emergency support measures have already been put in place. The one thing to look out for is whether the Bank pre-announces further quantitative easing in view of the speed with which it is working through its initial £200bn allocation to bond purchases which might run out as early as next month.
Emergency policy measures, meanwhile, are fuelling a vigorous debate about whether massive money printing risks a resurgence of inflation or a deflationary return of austerity measures. Which becomes more likely depends on the willingness of governments and central banks to tolerate high levels of public sector debt. And here there is wide disagreement between economists who have been flying blind ever since the financial crisis ushered in an environment of zero interest rates and quantitative easing.
On the corporate front, the pace of company trading statements is slowing this week, with just a handful of results on either side of the Atlantic. More attention is being paid to the survival or not of companies than their earnings. This week, J Crew, the US clothing chain filed for bankruptcy protection, the first big US retailer to succumb to the coronavirus, while Norwegian Air said it was close to a debt for equity swap that would allow it to qualify for government aid. Travelodge, the budget hotel chain, has written to landlords asking for them to accept lower rents in light of its expected revenue slump.
Commodities remain in focus too, with the oil price vulnerable to continuing volatility as slumping demand bumps up against massive oversupply despite the cut in production announced by Saudi Arabia, Russia and other OPEC countries. The lack of available storage facilities in today’s oversupplied market raises the spectre of another dip into negative oil prices as the monthly delivery deadlines for WTI contracts approach.
Meanwhile gold hovers around $1,700 an ounce, up 12% year to date, as investors seek out safe havens. With real interest rates negative, there is little reason not to hold gold, which pays no income, as a portfolio diversifier. UBS said this week that it believed gold could soon break through $1,800 an ounce. A number of hedge funds have been building up stakes in the precious metal as protection against a perceived debasement of currencies by money-printing governments around the world. The World Gold Council said this week that purchases of gold ETFs rose seven-fold in the first quarter.