In this week’s market update: shares rally as investors see the glass as half full; the US labour market surprises everyone; and economies re-open to save the summer.
Shares, in particular on Wall Street, continued to rally this week as investors latched on to the unexpected good news in last Friday’s non-farm payrolls report. A far better than forecast labour report persuaded the markets that recovery from the pandemic might be quicker and fuller than feared.
Against expectations of 7.5m further job losses, Friday’s employment reports showed a 2.5m improvement. That 10m swing capped another strong week for shares which, in the US at least, hae now recovered all the lost ground so far in 2020. The S&P 500 has now just turned positive for the year to date and stands 40% higher than at the low point in March. The tech-heavy Nasdaq index is more than 10% up year to date.
The market rally comes despite a still high death toll in America and the ongoing civil disruption triggered by the death at the hands of Minneapolis police of George Floyd, an unarmed 46-year old black man. Those protests have been mirrored all around the world as the pandemic has focused attention on existing inequalities that have been highlighted by the disproportionate impact of Covid-19 on minority communities.
The rally also comes in the face of continuing poor economic and corporate news. This week, Germany announced an 18% fall in industrial output in May, as the country’s main export markets remain under the influence of the Covid-19 lockdowns. Here, BP announced it was cutting 10,000 out of its 70,000 workforce.
On a smaller scale, but indicative of the extreme pressure that many companies are under at the moment, luxury retailer Mulberry said it was consulting with staff about potentially letting go 25% of its 1,400 staff.
The hardest-hit sectors are desperately working out how to manage their businesses through the ongoing crisis. One example: mid-market eating out chain The Restaurant Group said it was considering a so-called company voluntary arrangement which would allow it to cut its rental bill, with obvious knock-on impact on its landlords. Last week the company said it was looking to close 120 sites, affecting up to 3,000 staff.
A big fear here in the UK surrounds the end of the furlough scheme, which has seen the government picking up the tab for 80% of staff costs in a bid to keep workers on companies books through the worst of the pandemic. With that scheme due to wind down between August and October, a big spike in jobless claims is expected with the worst forecasts pointing to 5 million jobless, or 15% of the workforce, which would be the worst employment situation since the Great Depression.
America is leading the stock market pack but elsewhere markets are performing well too. European shares are now just 10% off their peak, having fallen by as much as 40% in February and March. The FTSE 100 index, which dipped below 5,000 is now 30% higher at more than 6,400.
That’s partly justified by glimmers of economic hope. Data in Asia is starting to emerge better than forecast as the region, which entered the crisis first, starts to emerge first too. In China, exports shrank by 3.3% in May, much less than economists had forecast. Japan’s first quarter GDP shrank by 2.2%, again much better than the 3.4% that had been forecast.
But the mismatch between resurgent stock markets and dire economic and corporate headlines is puzzling for many investors who are wondering whether they have been presented with a second bite of the cherry when it comes to protecting their portfolios against the possibility of another sharp correction.
Bear markets often enjoy a significant rally after an initial correction, which can pull investors back into the market before a more significant downturn gets underway.
A key factor in the stock market’s rally has been the influence of the US central bank, the Federal Reserve. Having slashed interest rates back almost to zero, launched unlimited bond buying and announced a string of new lending facilities, it cannot be accused of being slow off the mark in countering the impact of the pandemic.
Attention will focus this week on what else it might have up its sleeve if required. The Fed’s regular two-day meeting concludes on Wednesday and investors will be looking for references either to the possibility of negative interest rates (unlikely) or yield-curve control, where the central bank vows to do whatever it needs to in order to keep bond yields at or below a certain level. This is thought to be a likely next step.
Investors may not have long to wait to see whether the market or the headlines have got it right. As the government rushes through its planned opening of the economy, it is taking a significant gamble on avoiding a major spike in infections. With thousands apparently disregarding social distancing measures during Black Lives Matters protests and expectations that pubs and restaurants could be allowed to re-open in two weeks’ time, there is meaningful potential for a rise in new cases.
Different countries are in very different situations regarding the re-opening of their economies but the desire not to be left behind economically is forcing some to take big risks with the speed of the return to work.
New Zealand is getting back to normal form a position of strength, having declared that is has eliminated the disease with the emergence from isolation of its final case. By contrast, many emerging market economies find themselves in a much worse position. India is busily re-opening its economy despite still being in the thick of its Covid outbreak. Countries like South Africa do not have the fiscal flexibility to support the economy in the way that has been possible in many developed countries. Other countries like Brazil have simply been in denial about the scale of the problem they face.
The difference between these countries and those emerging market economies that handled the pandemic more effectively like China, Taiwan and South Korea is making the whole concept of emerging market investing almost redundant. It is no longer possible to generalise about these countries in the way that perhaps made more sense a few years ago.
In other market news this week, Russia and Opec agreed at the weekend to extend supply cuts for another month in order to support the oil price at its current level of around $40 a barrel, roughly twice the level it reached in April. The big oil producers are treading a fine line between supporting the price at a level which balances their fiscal books but doesn’t push it to a level where it squeezes an already stretched global economy.
Asset allocators looking to diversify away from now more expensive equities have done well in commodity markets in recent weeks but a survey this week from Absolute Strategy Research showed that one of their biggest bets at the moment is on corporate bonds. Despite fund managers expectation that there is an 80% chance of a recession in the next 12 months, they are backing both investment grade and high yield corporate bonds over normally safer government debt. This reflects in part the promises made by central banks to support markets by buying corporate bonds for the first time.
Investors are essentially betting that the current crisis is one of illiquidity not insolvency. They predict a strong recovery, with central banks having companies’ backs, and rising yields (and so falling prices) on government bonds. Only time will tell whether that optimistic view of the world survives a long-hot summer of re-opening economies, cash-strapped companies and nervous consumers.