In this week’s market update: the transition from Trump to Biden hogs the headlines; China’s fourth quarter GDP shows the country back at pre-pandemic growth levels while the ECB ponders how to dig Europe out of medical and economic crisis. Earnings season gets into full swing too.
All eyes will be on Washington this week as Joe Biden is sworn is as the 46th President of the United States. It’s probably not the biggest market news of the week, however, as the transition to a Biden presidency has already been well trailed.
Perhaps more influential will be yesterday’s Chinese GDP data, which confirmed that the country where the pandemic started more than a year ago is already coming out the other side. Growth in China in the fourth quarter was 6.5% and the country is now growing at pre-pandemic levels again.
China will almost certainly be the only major country to deliver positive economic growth in 2020 despite registering its first quarterly decline in output for more than 40 years in the first three months of the year. Overall growth reached 2.3% for the year as a whole, with state supported industrial production leading the recovery.
Chinese shares were up another 1.1% yesterday, building on the strong gains made in 2020 as it became clear that the country would be first in and first out of the crisis. The data were not all good because retail sales growth, at 4.6%, was marginally lower than in November and below expectations. Consumer spending has been the weakest link in the Chinese recovery.
But industrial production growing at 7.1%, in part due to buoyant demand for medical equipment and lockdown-related products, is firing on all cylinders. Growth in the previous quarter was 5.6%.
The good news for China’s economy has already been reflected in demand for the Chinese currency. The renminbi has risen above 6.5 to the dollar for the first time in three years. Chinese stocks are soaring and demand for commodities has risen sharply.
It’s a very different picture in the US and Europe where the pandemic hit harder both in terms of the human cost and in economic terms too.
This week the European Central Bank meets on Thursday for its first rate-setting decision of the year. Although a vaccine related rebound is expected later in the year, ECB president Christine Lagarde has made it clear that this is not the moment for monetary tightening.
Her comments have come against a background of extended lockdowns in major European economies including Germany, which said restrictions would remain in place for up to another 8 to 10 weeks. The ECB has said that if lockdowns persist, or if there is a delay in the roll-out of vaccinations, it could implement further bond buying to boost the economy.
The ECB is also keeping a close eye on the strength of the euro which threatens to reduce weak inflation even further as it reduces the cost of imports.
Meanwhile the Bank of England, which doesn’t meet again until February, is being watched closely by investors for indications as to whether it will put negative interest rates back on the agenda. The UK is expected to head into a double dip recession thanks to the extended New Year lockdown, which looks likely to continue until March at the earliest.
The Bank is resistant to negative rates, which are seen as potentially counter-productive if they discourage lending by banks. Much will depend on the success of the UK’s roll-out of vaccinations which is running faster than in much of Europe. The government’s stated position is that all adults will be vaccinated by September although it is thought that an earlier completion date in the early summer is actually possible.
The health of the UK economy will come into greater focus this week as inflation data and retail sales are unveiled on Wednesday and Friday respectively.
Coming back to this week’s inauguration, much may have already been priced in but that is not to say that it has not had a big impact on markets. The blue wave may be smaller than expected but it still provides president-elect Biden with at least two years in which the Democrats will control both houses of Congress as well as the White House.
That makes it much more likely that his progressive tax and spend agenda will make it through the legislative process. The first downpayment on that was announced last week in the form of a $1.9trn stimulus package including direct payments to individuals of up to $1,400 each. There are also plans to boost infrastructure spending, part paid for by higher taxes on companies and wealthier individuals.
The effect of that programme has been anticipated by investors who have rotated their portfolios away from the high growth tech stocks that have dominated the leader board in recent years and back towards more out of favour sectors that might benefit in a higher growth, more inflationary environment. Commodities, small caps, financials, basic materials and other cyclicals have picked up the leadership baton.
There has also been a big influence on the bond market where the expectation of higher bond issuance together with higher inflation, less bond buying by the Federal Reserve and perhaps higher interest rates sooner than expected have combined to push bond yields higher and so bond prices lower.
This will have an unpredictable impact on other asset classes. It is obviously bad news for high growth stocks which in some ways behave like long-duration bonds, benefiting from the prospect of low interest rates and low inflation. In a higher interest rate, higher inflation environment investors are looking for stocks with less stretched valuations and where less of the overall value is accounted for by long-term growth expectations that may be disappointed.
The key measure of inflation expectations, so-called break-even rates, have risen above 2% from just 0.5% in the depths of the crisis last year.
On the face of it rising bond yields are bad news for shares because they increase the incentive to hold higher-yielding fixed income investments. On the other hand, falling bond prices after years of gains from fixed income may encourage some investors to switch into equities which are more exposed to recovery.
On the corporate front, the main focus on this side of the Atlantic is still on the Christmas trading statements. This week we hear from the likes of W H Smith, Wetherspoons and Dixons. Three big commodity producers - Rio Tinto, BHP and Antofagasta - will also update investors.
Over in the states, fourth quarter earnings season, which started last week with some strong bank results, is getting into full swing. There are more banks this week, including Goldman Sachs and Morgan Stanley. But attention will also focus on Netflix, one of the main beneficiaries of lockdown, and Procter & Gamble, a classic defensive stock that should have held up well through the crisis.