In this week’s market update: Shares continue to rally on hopes for lockdown easing; investors focus on life after the crisis; and what did we learn from first quarter earnings?
Markets are continuing to grind higher, regaining their poise as investors become more confident that the easing of strict lockdowns can be achieved without a resurgence of Covid-19 infections. In a watershed moment in the recovery yesterday, the S&P 500 rose above 3,000 for the first time since early March before closing just below that level. The US benchmark is now 30% higher than at its low point on 23rd March while Germany’s DAX is 40% off its low.
Here in the UK, non-essential retailers will be allowed to re-open on 15 June as long as the infection and death toll data continue to move in the right direction. Economic activity in the week starting 11 May, two weeks ago, was back to 80% of normal levels, driven by higher retail sales both on and offline.
Japan, meanwhile, has lifted its state of emergency after seven weeks, declaring victory over coronavirus without the kind of lockdowns employed in other countries.
Japan has managed to keep infections at a much lower level than other comparable advanced countries for reasons that are not completely clear. Some point to a culture of compliance with government advice and a history of preventive mask-wearing to avoid infecting others.
Japan reported just 17,000 cases of coronavirus and only 830 deaths.
In continental Europe, German consumer confidence figures showed a modest rise suggesting a turning point may have been reached in the region’s biggest economy. The country is reported to be ready to lift travel restrictions on 31 countries in the middle of June.
The prospect of easier travel gave a boost to airline stocks, as did the announcement of a €9bn bail-out for German flag-carrier Lufthansa. Easyjet, InterContinental Hotels and British Airways owner IAG all had double digit share price gains.
Overall, rising risk appetite was reflected in European stock markets picking up on Monday’s strong start to the week outside the US and UK which were both closed for public holidays.
The FTSE 100 rose by 1.6% on Tuesday, the Stoxx Europe index was more than 1% stronger, building on gains in Asia such as Japan’s 2.2% rise and 1.9% in Hong Kong, despite simmering fears about China’s security clampdown in the city which took half of that gain back on Wednesday.
South Korea was 1.8% higher and Australia, particularly geared to an economic pick-up via its commodities exposure, was 2.9% up.
In other markets, risk appetite was reflected in further gains for the oil price. Brent now trades at around $36 a barrel while the US WTI contract is at $34. In currencies, sterling rebounded on hopes for the re-opening of retail, up to $1.23.
As economies re-open, investors are focused on the shape of the likely economic recovery with a whole alphabet soup of possible scenarios being proposed.
There remain some proponents of the V-shaped recovery on the back of massive monetary and fiscal stimulus and successful ends to lockdown. A variant of this, the Z-shaped recovery sees a sharp recovery to above the previous growth trajectory followed by a settling back to trend.
Most economists’ central case is the U-shaped recovery which gets back to trend growth but after a longer slump than with the V-shaped recovery. A variant of the U-shape is the W-recovery which has
an initial strong recovery almost back to trend growth but a relapse on the back of a premature opening up of the economy and a rise in infections before the economy finally gets back on track again after the mid-recovery lapse.
Another widely-discussed option is the L-shaped recovery which sees a permanent loss of growth so that even when the economy returns to its previous rate of growth it does so at a lower absolute level of output. This outcome sees some permanent scarring of the economy and is similar to the 90% economy recently described by the Economist magazine. This sees growth returning but a weaker kind of normal, with nervous consumers cutting back on activities they previously took for granted like eating out, shopping and travelling.
Which of these outcomes we end up experiencing is, of course, key to understanding whether the stock market is correctly pricing in the new economic landscape.
The long-term future of various sectors is also starting to be debated as we focus on what the future holds for offices, shops and restaurants among others.
The success of working from home for those businesses that have been able to shift easily to more flexible working has cast doubt on the extent to which companies will ever return to their previous office-focused set-ups. The problems of social distancing in an office setting and the very obvious cost-savings achievable with a wholesale move to working from home is likely to make this way of working much more mainstream.
This will obviously have significant implications for the real estate business and for commuter transport.
As for shopping, the re-opening of non-essential stores next month will quickly show the limitations of bricks and mortar retail in a world of social distancing. Shopping is in large part a social activity and with that element removed by the need to remain apart from other shoppers it may well be that the move towards online shopping accelerates.
Perhaps hardest hit will be the restaurant business. Already dependent in cities on business diners, restaurants are at the back of the queue for re-opening and, even when they do, they face the challenge of persuading people that eating in a socially distanced way is something they wish to pay for. It is hard to see a situation where there aren’t mass closures and redundancies in this people-intensive sector.
But much of that lies in the future. What about the here and now? As we come to the end of the first quarter reporting season, what can we learn from the company results that we have seen for the first three months of the year?
The first point to make is that the first quarter was only partially impacted by the Covid outbreak and the lockdown measures taken to control it. The main economic and company profit hit will therefore not show up in the figures until the second quarter.
This might explain why actual results did not look too bad against expectations. Key features of the results season included the lack of guidance from many companies. This is unsurprising given the lack of visibility affecting many sectors, but it did create a them and us divide between those companies that were able to provide some clarity and those that couldn’t. The share prices of more predictable businesses were rewarded.
The second focus was on dividends. The UK has already started to experience a sharp downturn in dividend payments, but this is yet to really be seen in the US. A comparison with the downturn in pay-outs during and after the financial crisis 12 years ago suggests there may be some way to go before dividends fully reflect the changed outlook.
Given the high degree of uncertainty, it is reasonable to ask whether today’s share prices adequately reflect the risks involved. The S&P 500 is now only 9% down year to date and the Nasdaq index is actually higher than at the start of the year. With earnings forecasts being reined in, that means that valuation multiples are relatively high. Essentially, they are pricing in a rapid return to normality. This argues for caution.
In other market developments, Hong Kong’s stock market suffered its worst one day fall in five years last Friday after Beijing said it would be introducing new security laws in the city to counter subversion, terrorism and foreign interference. The intervention threatens the one country, two systems agreement that has prevailed in Hong Kong since the handover from British rule in 1997. More importantly it threatens the special treatment afforded the former colony by the US and undermines its role as the pre-eminent financial centre in Asia.
Also in focus this week is Brexit, as negotiators prepare for a fourth round of talks between the UK and EU which are due to start next Monday. The pound is under pressure as investors watch the clock counting down on Britain’s ability to ask for an extension to the Brexit transition period. This is due to run out at the end of this year, but an extension must be requested by the end of June.