In this week’s market update: US stocks flirt with a new record high on the back of Chinese stimulus; investors shrug off plunging Japanese economic activity; and politics is back as the Democratic party convention focuses attention on a potential Biden Presidency.
The US stock market continues to climb a steep wall of worry as investors look for signs that the glass is half full. Further Chinese stimulus and a bullish year end market forecast from Goldman Sachs has carried more weight this week than a string of negative economic data announcements and growing worries about trade and Covid-19.
Chinese stocks set the week off on the front foot after the central bank in Beijing injected more than $100bn of liquidity into the financial system via a medium-term lending facility. That boosted China’s CSI 300 index of Shanghai and Shenzhen stocks by 2.4% on Monday and dragged Hong Kong shares higher too.
Evidence that the authorities remain committed to doing what is necessary to support economies around the world are part of the case for shares being made by Goldman Sachs, which said this week that it expects the S&P 500 index to end the year at 3,600, nearly 10% up from today’s level. The bank’s chief US strategist said that share prices should reflect not just the future stream of earnings from companies but also the rate at which those earnings should be discounted back to arrive at a present value.
If interest rates and bond yields remain low, then the value of earnings years into the future is higher today because investors can expect their real value to be eroded less by inflation.
In a separate note last week, Goldman listed other reasons to be more cheerful about shares. These included the faster than expected recovery in GDP since the low point in April in some countries and more optimism about the likelihood of a vaccine being developed earlier than expected next year. The bank also pointed to the effectiveness of low-cost measures like the widespread adoption of masks in public places, making further widespread, and economically damaging, lockdowns less likely.
Investors enthusiasm for US shares is unsurprising given the much stronger performance of Wall Street since the bottom of the pandemic market slump in February and March. The S&P 500 index has clawed back more than 99% of the losses since then but other major indices, especially those in Europe, have lagged far behind.
Italy’s MIB index has recovered just over 60% of its losses, with France and the UK doing a little worse at just 59% and 58% respectively. In large part this reflects the make-up of the various markets, with the US benefiting from its exposure to the best-performing sectors like technology and healthcare.
Large technology stocks continue to lead the market higher, raising some fears that investors are repeating their love affair with a narrow segment of the market that led to the dot.com bubble and bust 20 years ago. Valuations are not yet at the same high levels but there are other similarities such as the persistent underperformance of smaller stocks compared with larger ones and the outperformance of the growth investment style over value.
There remains plenty to worry about in addition to these historic echoes. Japan this week added to the gloom surrounding last week’s UK GDP report, with news that the Japanese economy contracted by 7.8% in the second quarter. This was a record decline for a three-month period. Although better than most of the other big global economies (and less than half the 20% decline recorded in the UK), it was steeper than the falls in South Korea and Taiwan in Asia. Japanese shares fell on Monday on the back of the economic news and again on Tuesday as trade fears added to the nervous tone.
The fall in Japanese GDP was the third in a row as the pandemic piled pressure on an economy already reeling from a hike in VAT last autumn. Around half the decline in activity came from lower private consumption as the country imposed a voluntary lockdown and about half from lower exports as the rest of the world shut down. Japan is suffering from a rise in infections although it has so far resisted declaring a further state of emergency.
In Europe, the threat of a second wave of infections took its toll on the region’s crucial summer holiday tourism season. The UK imposed new quarantine restrictions on travellers from France, affecting tens of thousands of people either already in France or planning to go during the peak holiday season. France is the second biggest holiday destination for British holidaymakers after Spain, where travel is also subject to quarantine measures.
Covid-19 is not the only concern for investors at the moment. Many of the things exercising investors’ minds before the pandemic are returning to the fore, with trade war fears intensifying this week after Donald Trump raised the stakes in the stand-off between Washington and Beijing. Over the weekend, he indicated that he was considering further action against Chinese companies such as e-commerce giant Alibaba just a day after he ordered Byte Dance to sell its US Tik Tok operations within 90 days.
The President also ended a waiver for some US companies to continue trading with telecoms group Huawei, a company that the US believes is complicit in Chinese spying on America.
The latest escalation in the trade war confirms the rapid deterioration in a relationship between the world’s two biggest economies which has put business concerns ahead of strategic rivalry for more than four decades. Having started with trade disputes, the battle has shifted to technology and finance, sweeping more and more parts of the two economies into its grip as a new Cold War develops.
The prospect of any improvement in the situation is slim in light of the now bi-partisan nature of anti-Chinese feeling in the US. Joe Biden is no keener on a rapprochement with Beijing than Donald Trump so, whoever wins the November Presidential election, the pressure will continue. And it is likely to be reciprocated because, since President Xi Jinping took power in 2012, China too has put a newly assertive sovereignty ahead of commercial considerations.
The relationship with China is just one aspect of a potential Biden Presidency that markets are starting to analyse this week as the first completely virtual Democratic Party convention gets underway. This is the event at which the former Delaware senator will be officially confirmed as the anti-Trump candidate in November’s vote.
With Biden now well ahead of Trump in the polls, individuals, businesses and particularly investors are starting to look at what his policy agenda might mean.
Top of the agenda is tax, where he has promised to undo Donald Trump’s tax cuts, raising the top rate of income tax back to 39.6% from 37% and increasing the corporate tax rate from 21% to 28%. He has proposed aligning capital gains tax with income tax for higher earners. In order to push through his tax plan, he will need the Democrats to take back control of the Senate, especially if he is to divert the extra money raised to more infrastructure spending, notably green infrastructure.
When it comes to Wall Street and the financial services industry, which has benefited from deregulation under Donald Trump, there is relief that Biden is not as progressive as his former opponent in the race for the nomination, Elizabeth Warren. However, the Massachusetts senator is expected to wield significant influence and may even appear in a Biden cabinet.
On technology, another target of Warren’s, Biden has called for Amazon to pay more tax and to repeal a law that gives social media companies protection from libel cases based on content uploaded by users. When it comes to the energy sector, a Biden Presidency would mark a significant shift from the current administration, with a much greater focus on decarbonising the energy system, including a $2trn plan to add renewable generation capacity, to electrify much of the transport system and to research greener technologies to replace fossil fuel generated power.
On foreign policy, a shift to the Democrats would represent a return to a greater integration of the US into the global system, closer relations with Europe and other allies, rejoining the Paris climate accord and restarting nuclear talks with Iran. On immigration, Biden has pledged to reverse many of Trump’s more restrictive policies.
So, there is plenty to play for and the next three months will be dominated by US politics as they always are at this point of the four-year Presidential cycle.
Here politics is also back on the agenda with the clock ticking down on the Brexit negotiations between the UK and the EU. This week attention is focused on financial services, with the European Commission warning the City of London that it still may not know by the end of this year, when Brexit proper finally arrives and Britain’s financial services passport expires, whether it will have access to the EU’s 27 other markets as one unified bloc. The issue is whether Britain will qualify for so-called equivalence, whereby our rules and regulations are deemed to be equal to those of the EU itself.
And, finally, some more worrying news for active managers for whom sustainable investing, or ESG, has been seen as an area where they retain an edge over passive, or tracker, funds. With money pouring into sustainable funds, even as it is taken out of traditional funds, this was seen as providing some respite for active managers who have faced a barrage of competition in recent years from cheaper passive funds. New research, however, shows that more than half of investors think the majority of their ESG investments will be passive within the next five years. Currently just 21% of sustainable funds are managed passively.