In this week’s market update: in a quiet August week for company and economic news, there is still plenty for investors to focus on, including: a pick up in M&A activity, concerns about inflation and a surge of bond issuance, increased ESG fund flows and heightened tensions between China and the US.
The usual summer holiday lull has arrived, with little to focus on from a company or economic data perspective. But that doesn’t mean there isn’t plenty for investors to think about as markets remain in a holding pattern, pulled in different directions by coronavirus fears and slowing economic activity on the one hand and active government and central bank stimulus on the other.
Markets have started the week on a positive tone, with Japan and Hong Kong both adding more than 2% on Tuesday on vague hopes for more stimulus in the US. Chinese and Australian stocks also rose more than 1% adding to Monday’s more modest gains in Europe and the US.
Corporate news this week is notably thin on the ground. Here in the UK, there is a sprinkling of results announcements, with the biggest names being Prudential, Intercontinental Hotels, Admiral, National Express, TUI and GVC. The former Sports Direct, or Frasers as it is now known, could provide some colour, although it’s unlikely there’ll be a repeat of last year’s fiasco when the company failed to sign off its numbers in time to deliver to waiting analysts. Over in the States, other than an update from Cisco there is almost nothing of note as the second quarter results season is now effectively complete.
On the economic front, yesterday’s Chinese inflation data, the first cut of UK GDP on Wednesday and retail sales data in both China and the US on Friday are the main highlights.
So, China and the US end the week, and their troubled relationship began it too after Donald Trump imposed fresh sanctions on China, which responded this week with a measured tit-for-tat response. Both sides have imposed sanctions on 11 individuals, including Hong Kong’s chief executive Carrie Lam. China’s targets included a number of senior senators and a Congressman.
The escalation of the economic cold war between the two countries follows the imposition on Hong Kong of a new national security law in contravention of the ‘one country, two systems’ framework which was meant to apply in the former British colony until 2047. China has this week made its highest profile arrest yet under the new law, of media tycoon Jimmy Lai. Western critics have also called out the postponement of legislative elections scheduled for September under cover of the coronavirus outbreak.
The market impact of the renewed tensions has been felt most strongly in China itself with shares in big Chinese tech stocks hit hard by restrictions on the ability of US companies to deal with the likes of Tencent, which fell 4.8% on Monday after a 5.5% slide on Friday. Alibaba, another higher profile e-commerce stock, fell 2.7%, despite not being directly impacted by the corporate restrictions.
This week’s GDP figures here in the UK are likely to show that Britain is now officially in recession, having delivered two consecutive quarters of negative growth. In the first three months of the year the UK economy shrank by 2% as the coronavirus saw activity contract at a record pace in March. The second quarter will be scarred by the effective shut down of activity in April.
Perhaps more important than the overall growth figure for the quarter as a whole will be the shape of the recovery in May and June. Because of this the data will be unusually difficult to read this time and many economists will take the indication of recession with a pinch of salt. Everyone knows that these are unprecedented economic times.
Top of the agenda for UK economy watchers is the jobs outlook, with a survey this week from the Chartered Institute of Personnel and Development indicating that a third of British companies are anticipating reducing staff in the third quarter as government support for employers is progressively reduced between now and October. When the CIPD last performed this survey three months ago the equivalent figure was 22%.
This week the Evening Standard said it would cut a third of jobs in the most far-reaching restructuring of a UK media group yet. British Airways is meanwhile bracing for industrial action as it begins to implement its plan to reduce staff numbers by 12,000, around 30% of the airline’s workforce.
Unemployment represents one of the biggest threats to economies the world over, with fears that it could lead to a negative feedback loop in which consumer confidence is hit by rising financial hardship or even just the fear of job losses. Many companies have no choice but to radically reshape their workforces in the face of lower demand, perhaps for the foreseeable future.
As investors look beyond the immediate impact of the pandemic, other economic and financial consequences are starting to dominate market thinking. One of the main fears stalking stock markets is a return of inflation thanks to the extraordinary monetary and fiscal stimulus measures that have been implemented to fend off recession or worse.
Morgan Stanley said this week that aggressive monetary and fiscal action could trigger a burst of inflation that the Federal Reserve might struggle to control. This in turn could be the trigger for a stock market correction, especially if rising prices combine with sluggish growth - the so-called stagflation mix.
Money supply, which is widely understood to be the key driver of inflation, has rocketed so far this year, rising much faster even than in previous bouts of central bank intervention such as after the financial crisis in 2008.
There was a fear that this could trigger inflation a decade ago as well, but a price spiral failed to materialise. This time, however, experts fear that the combination of monetary and fiscal policy could create the right conditions for prices to rise sharply.
The impact on financial markets is already being felt. The price of gold, which investors see as a hedge against inflation, has continued to hit new all-time highs above $2,000 an ounce. This week the sharp rise in the gold price helped one of the world’s biggest gold miners, Barrick Gold, to more than double profits, exceeding expectations. Revenues at the company rose 48% from the same three months last year despite a fall in production thanks to coronavirus disruptions at mines in Argentina.
Another perhaps unexpected consequence of the pandemic has been a sharp pick up in mergers and acquisitions activity in recent weeks as companies seek to bolster their defences against challenging trading conditions. A series of blockbuster deals has driven a resurgence of activity since the start of July.
There have been eight deals of more than $10bn signed in the past six weeks according to Refinitiv. It’s the fastest start to the second half for deal-makers since 2007 when the market was booming ahead of the financial crisis. Initially the pandemic killed off interest in takeovers but since prices started recovering, so too has investors appetite to support deals. Both June and July saw more than $300bn of deals compared with $100bn in April and $130bn in May.
The rationale for the deals is tending to be strategic tie-ups in industries hardest hit by the pandemic and a rising number of private-equity deals. Companies are looking to build resilience and scale.
One interesting aspect of investment markets since March has been the enduring popularity of sustainable, or ESG-focused, funds. A reasonable assumption during the market volatility of March and April might have been that a focus on environmental, social and governance factors would become a luxury that investors would feel able to do without. The reverse has been the case.
Record sums have been invested in sustainable funds during the pandemic, more than $70bn between April and June according to new figures from Morningstar. That has pushed the amount invested in these strategies to more than $1trn.
That still represents a small proportion of the $41trn or so invested in funds worldwide but it shows that investors still take issues like the environment and climate change seriously and that they have realised that attention to social and governance issues can be an accurate marker of overall corporate and management quality.
The resilience of ESG funds has provided a boost to active managers as most of these funds are actively managed. It has provided at least some respite from the concerted attack on the active fund industry by passive, tracker funds, which in recent years have taken the lion’s share of investment flows.
One final interesting market development this summer, again related to the pandemic, is an expected surge in bond issuance by governments that have committed to spending big on supporting their economies through the crisis. August is typically a quiet month for bond issuance but this year the next two weeks could see €22bn sold by Germany, France and Spain alone with Italy also waiting in the wings to raise cash.
The challenge faced by the governments trying to sell those bonds is that investors will not be in receipt of any funds from maturing bonds because of the lack of sales in August in previous years. That could deal a blow to the recent rally in government bonds which has seen the yields on Italian bonds, for example, fall to their lowest level since March, and Germany’s to their lowest since May.