In this week’s market update: stocks rally on hopes for post-election stimulus; earnings season gets underway; while here in Britain, new lockdown measures are announced, investors assess the impact of Brexit on markets and the Bank of England sounds out banks over negative interest rates.
Risk appetite started to return to markets last week as investors began to pin their hopes on further stimulus after the US Presidential election. Having been heavily oversold just a few weeks ago, with less than 10% of shares standing above their 20-day moving average, nearly 90% are currently running ahead of their recent performance.
Yesterday the S&P 500 closed 1.6% higher while the Nasdaq rose 2.6% as hopes for a decisive election result rose. Fears of a contested result had hung over markets recently, but Joe Biden’s poll lead of around 10 percentage points has remained steady.
Unlike a few weeks ago, when the market was being held up by a handful of stocks, the rally is now looking much more broad-based, with companies across the board hitting new highs. Even smaller companies, which had lagged the bigger stocks are coming close to their February levels. There is still a big divergence between winners and losers but sectors like energy and financials are also bouncing back.
Investors are gaining confidence that the V-shaped recovery in markets earlier in the year was not too much too fast but a fair reflection of a quick improvement in economic activity and then corporate earnings. US GDP in the 3rd quarter is expected to rise by around 29%, almost replacing the lost ground in the second quarter. Profits will take a while to follow through but should be on their way back early next year.
Investors are not just counting on more fiscal and monetary stimulus next year, they are also expecting that the Federal Reserve will help to fund higher government spending by keeping yields artificially low, as they did in the 1940s when war spending was offset by rock bottom interest rates even as inflation rose.
A return to this kind of policy is seen as providing a boost to asset prices, even if in the long run it creates inflationary problems. And it is not just the overall market level that will rise. The leadership of the market could also change significantly if a reflationary rally kicks in. Some believe this may be the trigger for a revival of cyclical value stocks, which have underperformed growth stocks in just the way they did during the financial crisis before massively outperforming during the 2009 rally.
This may not be the story of the upcoming earnings season, however, which is likely to confirm a wide divergence in earnings between those familiar pandemic winners in technology and healthcare and the losers in consumer facing businesses and cyclical areas like energy and finance. The value rotation may have to endure one more earnings season before it finally has its day.
This week’s earnings focus, as usual, will be on banks which traditionally report their results first. Pretty much all the big US banks will be announcing results this week in a flood of earnings announcements.
Looking on the bright side, it won’t be hard for earnings to beat the second quarter when earnings in the US fell by 32% and by 51% in Europe. The forecast drops in the latest three-month period are 21% in the US and 38% over here. Looking forward, the falls are expected to be even smaller in the final three months of the year before turning positive from the first quarter of 2021.
Earnings season will be competing for attention over the next few weeks over the pond with the US Presidential election, which is currently on course to deliver a Joe Biden victory if the polls are to be believed this time round. Four years ago, it should be remembered, the polls were pointing to a Hillary Clinton victory which failed to materialise in part thanks to the American voting system which makes it possible for a candidate to win the popular vote but fall short in key states and so lose the Presidency by amassing too few electoral college votes.
Perhaps more important from an investment perspective is what happens in the Congressional election, because any President is only able to push through their policy agenda with the support of the House of Representatives and Senate. The current polls have the odds of both the Senate and White House going blue, or Democrat, at roughly two thirds. But 2016 warns us not to make any assumptions before election day.
On this side of the Atlantic, markets have a different set of concerns. The first is the economic impact of the new lockdown restrictions confirmed yesterday by Boris Johnson, the Prime Minister. The new framework for regional curbs on freedom of movement involve the closure of pubs and restrictions on residents moving around without good reason.
The government is under mounting pressure from regional mayors and MPs to ease the pain of the new lockdowns. Recently announce measures are seen as less generous than those implemented during the national lockdown in the spring. Some industry associations have also launched a legal challenge to the plans, which will brand areas as medium, high or very high risk, with different rules applying to each.
Unemployment data today confirmed the scale of the jobs crisis facing the UK as the number of redundancies increased by a record 114,000 in the quarter to the end of August. The unemployment rate now stands at 2.7m, more than double the level in March before the lockdown began. The unemployment rate rose from 4.1% to 4.5%.
The need for tougher restrictions comes as infection rates and, crucially, hospitalisations have risen sharply in recent days and weeks. Scientists have warned that the UK is at a tipping point which could threaten the ability of the NHS to cope with a mounting case-load. The possibility of another national lockdown has been flagged.
The pandemic is one problem facing UK investors. Another is the imminent arrival of Brexit, which is due to kick in for real after an 11-month transition period at the end of the year. In reality, some kind of a fudge still seems like the most probable outcome, with some sectors aligned with EU regulations for a set period of time and others benefiting from transition arrangements to reduce the impact during a period of economic stress on both sides of the channel.
Of course, it is possible that an eleventh-hour compromise that allows both sides to claim victory cannot be achieved and one or both sides could walk away from talks. The best measure of these two possible outcomes will be pound. Karen Ward at JP Morgan thinks a deal would have the pound rising by 5% in trade weighted terms and no-deal seeing it fall by as much as 10%.
Just looking at the currency impact, a fall in sterling might be seen as a positive for the FTSE 100 because nearly 80% of revenues for companies in the index come from overseas. However, it’s not quite this simple. A failure to come to a deal would hit confidence and could further depress commodity prices, which are a key driver of the UK market. Financials too are important and an unfavourable outcome to Brexit talks would likely hit this sector hard too.
However, it is worth pointing out that the UK has been almost a pariah market for many years now and is considerably cheaper than most other comparable markets. Any sign of a deal emerging, however thin it looks, could be taken as a reason to jump into the out of favour UK market. In a low interest rate world, a dividend yield, even after recent cuts, of nearly 4% will look pretty compelling.
The Bank of England has said once again that it stands ready to move in force to support the UK economy if events on the pandemic front or with Brexit make that necessary. To that end it has recently contacted the UK’s banks to ask them about their readiness for negative interest rates if those become necessary in the Bank’s view. This latest move adds to a confusing set of mixed messages on negative rates in recent weeks. Current interest rates are 0.1% in the UK and speculation has mounted that Britain could follow Europe and Japan into an environment of sub-zero rates.