In this week’s market update: shares retreat on new lockdown fears; but higher prices encourage more companies to float their shares; and can the precious metals rally continue?
The week got off to a volatile start as new lockdown speculation in the UK over the weekend saw shares plunge in Europe on Monday morning. Asia had already picked up on Wall Street’s weak end to last week, setting the scene for a bruising day for investors.
The Prime Minister is expected to announce a 10pm closing time for pubs and to reverse recent attempts to get people back into the office. The moves come after warnings from Britain’s top scientists that Covid-19 risks running out of control after an uptick in infections. The threat level rose from three to four, which implies transmission of the virus is high or rising exponentially.
The main victims of the sell-off were inevitably the sectors seen at most risk of new restrictions on movement. BA-owner IAG was the biggest faller in the UK, down more than 12% as the latest news piled on the pressure for the airline industry.
Overall the FTSE 100 fell 3.4% on Monday. Germany’s DAX was off 4%. Spain said it too was ready to step up restrictions. Wall Street added to Friday’s losses but was off by less than in Europe, down 1.2% on Monday.
Other travel stocks like InterContinental Hotels and Trainline were in the firing line. Only the most defensive stocks, supermarkets and food delivery companies, were spared the rout.
Also under pressure were cyclical stocks most exposed to the health of the economy. The banks were among the big fallers, as investors factored in an even longer period of the low interest rates which make it so hard for the financial sector to turn a profit.
The sector’s fortunes were not helped by a report that showed HSBC high up a list of banks that had flagged up trillions of dollars of suspicious financial transfers to US anti-money-laundering authorities. The bank’s shares fell to their lowest level in more than 25 years on the disclosures. They have fallen by more than 50% this year on the back of the coronavirus and tensions between Beijing and Washington.
Pandemic concerns were heightened after Britain’s leading scientists went on television to warn that infections could spiral in the next few weeks unless action was taken to stop the spread of the virus. The government is in a bind, trying to encourage people back to work while simultaneously wanting to avoid the charge that it has once again been slow to act.
The falls were in marked contrast to a survey of fund managers this week which showed that most expect earnings to be higher in 12 months than they are now, with shares expected to outperform bonds and cyclical stocks to do better than defensives.
For that to happen, there would need to be a significant pick up in the economy, which fears about sharply rising unemployment in the autumn appear to make unlikely.
Andrew Bailey, the governor of the Bank of England, will be under scrutiny this week after the minutes of the latest rate-setting meeting in Threadneedle St last week appeared to raise the likelihood of negative interest rates being implemented in the UK.
So far, Europe and Japan have adopted a policy of cutting interest rates below zero but the approach has been resisted by Britain and the US. Their hesitation reflects question marks over the effectiveness of negative rates, which some economists believe might actually hinder rather than boost growth.
When Bailey took over as governor he was quoted as saying that he was not even thinking about negative rates so the latest admission that Bank officials have briefed the monetary policy committee about their implications marks an about turn.
One problem is the impact sub-zero rates have on the banks, making them less profitable and so less likely to risk lending money to households and businesses. Another is the existence of a so-called reversal rate below which lower borrowing costs don’t encourage more spending but constrain it because of the negative message the rates send out about growth prospects.
Although shares have been weak recently, the US market has recouped all of the losses it incurred during the sharp falls in February and March. That V-shaped recovery has encouraged something of a mini-boom in new flotations or IPOs.
Companies which had been hoping to tap investors for new funds have decided, if not now then when, and taken the plunge. One of the biggest and most high profile of these new issues has been Snowflake, which saw its shares soar in early dealings to take its valuation to about $70bn, or 140 times its most recent revenues, or nearly six times what investors thought the company was worth in a private fund-raising earlier this year.
Snowflake is a cloud computing business so at the sharp end of recent trends in the technology industry but its popularity has evoked memories of the dot.com bubble 20 years ago when similar share price surges took place before the market eventually ran out of steam and boom turned to bust.
The flotation of Snowflake is the biggest of the year and the largest since Uber floated last May. And it is just one of many. Last week a dozen companies joined the stock market, many of which are in the technology field. Unity, a video game software company raised more than $1bn and the amount raised in 2020 is now the highest since 2014 when Alibaba set a record with its $25bn flotation.
The rise in prices, and the surge in valuation measures it implies, has raised questions about whether the market has lost touch with reality on the back of excessive monetary and fiscal stimulus. Valuations have certainly risen strongly since the spring - in the case of the S&P 500 index from about 13 to 23 - but this is not so unusual in the early stages of a stock market rally.
After a market bottom the gains achieved in the first 6-12 months are often caused by rising multiples rather than improvements in earnings which usually lag the market movement by half a year or so. Higher prices combine with still falling earnings to produce sometimes eye-watering valuations. In due course, earnings catch up and the PE ratio falls without necessarily causing share prices themselves to fall.
There are a couple of reasons to think that valuations and prices can remain high. First, stimulus is likely to continue until a vaccine is found. Despite the hopes, this is probably not an issue until the middle of next year at least. Second, shares may be high but they look relatively cheap compared with bonds.
The other big question exercising investors today is whether inflation is on its way back. The answer to this matters because it will affect many issues of importance to the markets - asset allocation, whether the growth or value style prevails and where in the world the best performance will be found.
Unfortunately there isn’t a simple answer. On one hand, the scale of monetary stimulus and the potential for pendulum to swing back from capital to labour under more populist governments could be inflationary. Compared to previous moments of crisis, like the 1930s, the policy response has been rapid and committed.
On the other hand, there are still some pretty big deflationary impulses at work in the global economy. The most important of these are debt and demographics, the two dead weights around the Japanese economy which have prevented even massive spending by the government there from translating into higher prices.
As long as growth remains hard to come by and inflation is subdued, the current trends - for the US to outperform and for growth to do better than value - will probably continue. And, it’s worth remembering too that the kind of correction we have had recently is typical during a bull market.
One asset class which has been in a spectacular bull market this year is precious metals. Gold gets most of the attention, but silver has actually done even better. The other precious metal has risen by more than 50% so far this year, making it one of the best performing of all assets.
Silver has an advantage over gold in that it is both considered a safe haven store of value but also a key industrial metal, in solar panels for example. Despite these attractions, the price of silver has remained range bound in recent weeks and holdings in the iShares Silver Trust, a barometer of demand, have fallen 3% in a month. The industrial uses that boost demand in an upturn could have the opposite effect if the global economy takes a second Covid hit.