In this week’s market update: some thoughts on the tech stock correction; mixed news from corporates; and a new chapter in Japan.
The S&P500 has fallen 8% from its recent high on 2 September. That’s not quite the correction already recorded by the tech-heavy Nasdaq index, but it is a significant pull back nonetheless. It prompts the question: is this a re-run of the June pause for breath or the start of something worse.
Back in June, the market action was driven more by retail investors, this time the culprit looks like derivatives trading by professionals, but the outcome is similar. First a big rally, then a sharp pull-back. In June the uptrend quickly re-asserted itself; this time we wait and see.
A key difference between the two corrections is that in June a rotation from tech stocks to cyclicals was in evidence. There were winners as well as losers. This time, more worryingly, the falls have been more broad-based.
The good news, for bulls, is that the correction has brought valuations a bit more into line, although those based on this year’s depressed earnings do still look a bit punchy. That’s to be expected. Share prices anticipate the future direction of profits and the thinking is still that these will recover next year.
This was certainly the case in 2009, when share prices looked very expensive at the bottom on the basis of recessionary earnings, but profits soon caught up.
Another justification for higher valuation multiples at the moment is the growth in financial liquidity thanks to the stimulus being provided by both central banks and governments. There’s a strong correlation between these so if the stimulus continues, as it probably will, we should get used to valuations looking high but staying that way.
For technical analysts who look at breaches of recent support levels, the moves of the past week or so are a concern. The number of shares above their recent moving average price levels is falling quickly. Smaller companies have failed to convincingly remain above their high from earlier in the summer. And the charts of high-flying tech stocks are doing a passable imitation of previous bubble and bust periods.
Much depends when looking at charts at your starting point. In the late 1990s, shares rose strongly for 18 months from the low they reached after the collapse of a high-profile hedge fund in 1998. If you superimpose the rally since March this year on that period, the current market gains look remarkably similar. If that analogy continues then shares may a way to run yet.
It’s worth noting that strong bull markets are often characterised by quite severe corrections along the way. Falls of 8-10% are not at all unusual. So, the current pull-back remains one to watch carefully rather than a reason to panic.
Market patterns are never repeated exactly, of course. There are always different things going on. Currencies are an important influence this time, for example. The fall in the pound against the dollar and euro last week had a big impact on the FTSE100, pushing the UK benchmark up 4% last week as the cost of British exports fell and the value of overseas earnings rose.
The rise in the Footsie was certainly not a reflection of positive headlines in the UK, with expectations rising that as many as 500,000 jobs could be lost in the autumn as the government’s furlough scheme is wound down.
This morning it emerged that the number of people on company payrolls was 700,000 lower in August than March. That was marginally better than a month ago but suggested that the re-opening of the hospitality sector in July had made only a modest difference to the UK jobs market. Around 5 million people, including those furloughed, are temporarily away from work and the added cost to employers as the furlough scheme winds down means the real employment picture is almost certainly worse than the figures suggest.
Brexit has also returned as a dark cloud hanging over the UK economy. The government has come in for heavy criticism for the way in which it has apparently ignored its obligations under international law with respect to the EU withdrawal agreement signed last year and now being significantly revised, on this side of the channel at least. The odds on a no-deal Brexit at the end of the year have shortened dramatically in the last week or so.
This is the back drop for the Bank of England’s regular rate-setting meeting this week. The jury remains out on whether the UK’s central bank will decide the risks to the economy have risen enough to warrant further support, but the chance of rates falling to zero or even into negative territory has increased.
The Bank has said only that negative rates are part of its potential toolkit but has so far resisted the temptation to follow European economies and Japan into rates of less than zero. We hear from the Bank on Thursday.
That is the day after the Federal Reserve reports on its own rate-setting meeting. This is the first since the Fed suggested at the Jackson Hole summit of global central bankers that it would be prepared to tolerate inflation running above its target for a while to compensate for long periods during which it has undershot. There is bound to be tough questioning of Fed chair Jay Powell on this topic at the press conference that follows Wednesday’s rate announcement.
The Fed meeting is the last before November’s Presidential election so its chairman will be choosing his words even more carefully than usual. The next meeting follows immediately after the 3rd November election, scheduled for the 4th and 5th of that month.
Meanwhile in Japan, a new political chapter is opening, with the announcement that chief cabinet secretary Yoshihide Suga won a landslide victory in the race to lead the ruling Liberal Democratic party. As a result, he will take over from Shinzo Abe, who is stepping down for health reasons as Prime Minister after eight years in the top job.
The key question from an investment perspective is whether the new PM will continue the so-called Abenomics programme of economic reforms that energised the Japanese market from 2012 but which in recent years have seemingly run out of steam. It is thought that the new hand on the tiller will look remarkably like the outgoing one, with a mixture of monetary and fiscal stimulus attempting to boost Japan’s still sluggish economy.
Japan received an unexpected vote of confidence recently when Warren Buffett burnished his contrarian investment credentials by buying big stakes in five of Japan’s leading trading houses. The move was seen as both a vote for Japan’s cheap and value-focused stock market but also a sign of his concern about the sustainability of the US’s stock market leadership.
On the corporate front, there has been plenty of mixed news this week. A report from fund manager the Leuthold Group calculated that there are more so-called zombie companies than at any point in the past 20 years. These are companies which find themselves in a twilight zone between survival and failure, supported by rock bottom interest rates and more recently the ability to issue bonds with the explicit support of central banks which are buying up the debts of more and more marginal companies.
So-called zombie companies are bad for economies because they hold back the natural process of creative destruction that recycles investment from weak companies to stronger ones. Productivity and growth are reduced in an economy that keeps these kinds of businesses on life support.
One company that is definitely not a zombie is Amazon, which announced this week that it planned to launch its fourth hiring spree of the year to date, taking on another 100,000 workers to bring its total employees to close to a million.
Less enthusiastic are companies at the sharp end of the pandemic which are getting used to the harsher reality of life under Covid-19. Cathay Pacific, for example, said this week that it would ground 40% of its aircraft for the foreseeable future as it battles with a collapse in passenger traffic. Its flights were just 20% full in August.
BP, too, has warned that Covid-19 may have brought forward the point of peak oil demand. The base case scenario in the oil major’s annual energy market review points to a recovery from this year’s lower oil demand followed by a peak in the early 2020s. But it also recognises the possibility that more aggressive policies to tackle climate change could result in 2019’s 100m barrels a day of demand proving to be high water mark for the industry.
The forecasts are a big change from only a year ago when BP was predicting rising demand for fossil fuels until the 2030s.