In this week’s market update: is the market ready to pause for breath; or will trillions of excess savings fuel an extended recovery?
We all know that history never repeats itself exactly in the stock market, but it does tend to rhyme. In other words, we can learn from the past but should never rely on previous episodes to guide us today.
The key comparison for investors today is what happened after the financial crisis in 2009. Back then, just like today, shares recovered strongly from the 2008 bear market. In the first year after the low in March 2009 the S&P 500 index rose by 74% in real, inflation-adjusted terms. Today the same US benchmark is up 82% on the same basis.
What happened next is typical of a bull market. Investors paused for breath and gave back some of their recent gains before returning to an upward trajectory with renewed vigour. The trigger for the pause in 2010 was the ending of the Fed’s first phase of quantitative easing or bond buying. The markets thought that was it as far as stimulus went and shares fell 17% over the summer.
For stock market historians, there’s another interesting parallel. In the 1940s, which actually looks more like today in terms of combined monetary and fiscal stimulus, shares rose by 53% in real terms up to the summer of 1943 but then fell back by 13% before again picking up the pace again.
So, unpleasant as corrections are, we should brace ourselves for the fact that we are arguably overdue a pause this summer. What might cause it?
What seems an unlikely trigger is a reversal of recent stimulus measures. The US government seems intent on spending big over the next few years and the Federal Reserve seems committed to supporting that effort with persistently easy monetary policy. That’s supportive.
But, as I often say, in investment it is better to travel than to arrive. Often markets do best in the hope phase when investors are looking through difficult headlines to better times ahead. We are just getting into the swing of first quarter earnings season and expectations are high. That puts a lot of pressure on company earnings to actually deliver or markets could face the consequences of disappointed expectations.
So far, the outlook remains positive. With about 40 of America’s leading companies having reported so far, the consensus for first quarter earnings growth has already risen by 6 percentage points. About 80% of companies reporting so far have beaten expectations by an average of more than 50%. Calendar year earnings are now expected to rise by 27%. In fact corporate earnings estimates are now back to where they were just before the pandemic.
This week sees earnings season broaden out from the banks which typically start things off. In particular, we have updates from some US airlines which will give an indication of how travel demand is picking up from the industry’s most calamitous year ever. The number of travellers remains below 2019 levels but is climbing steadily.
That all sounds very positive. On the other side of the equation, however, fund flows have levelled off a bit since peaking a few weeks ago and cash on the sidelines is rising, although this could arguably just reflect those stimulus cheques arriving and being parked in money market funds while people decide where to invest.
A couple of things suggest that investors are less gung ho about the recovery trade than they were. First, the big tech stocks, which have underperformed since the reflation trade kicked in last November have started to regain their relative performance. Second, and related to this, bond yields have fallen back from their recent highs. The 10-year Treasury yield, which was up at around 1.75% is now back below 1.60%. That suggests that investors are once again seeing some value in bonds after their recent underperformance.
Today’s circumstances are, of course, quite different from previous market cycles. No-one alive today has ever lived through a pandemic like Covid-19. And one of the key differences between this and other economic shocks is the way in which some people (not all, it should be said) have actually been treated quite kindly in financial terms by the last year.
It has been estimated that consumers around the world have put aside an extra $5.4trn of savings during the enforced lockdowns of the past 12 months. As people become more confident about the economic outlook, they are less inclined to sit on that cash and this paves the way for a potentially very strong rebound in spending as businesses re-open.
The US and UK are at the forefront of that process thanks to their better vaccination programmes and lower infection rates. Here in the UK we are just a week into a partial return to normal with outdoor hospitality resuming and some mass events being trialled.
It’s worth being a little cautious about the data because much of the excess savings have been accumulated by richer people who have a lower propensity to spend extra cash. The wealthier you are, the more likely you are to treat a windfall as simply an increase in your net worth rather than extra income to be spent.
However, even if only a third of the saved cash were released into the economy that could boost global GDP growth by around 2 percentage points both this year and next, according to Moody’s. That’s a significant rise in output.
One area that is clearly lagging the Anglo-Saxon recovery is Europe so this week’s ECB rate-setting meeting will be closely watched for what the European Central Bank might have up its sleeve to ease the impact of continuing lockdowns. Christine Lagarde last week described the eurozone as a patient who has walked out of intensive care but is still in need of crutches.
At the ECB’s last meeting it increased the pace at which it is buying up bonds under its €1.9trn pandemic emergency purchase programme or PEPP. Since then it has bought €19bn of bonds a week compared with a weekly average of €15bn earlier this year. The question this week is whether the ECB will go even further to support the European economy.
Here in the UK, it’s a busy week for economic data releases. We will see numbers on the labour market, inflation and retail sales. Of particular interest will be the inflation data which investors are viewing as a key market driver, and in particular an influence on whether the recent rotation from growth to value sectors of the market will continue.
Although inflation fell back in March from 0.7% to 0.4%, it is expected that the re-opening of the economy will lead to an upward trajectory for prices over the summer. If inflation starts to rise above the Bank of England’s 2% target questions will focus on whether interest rates will also start to rise.
The reality is that the central bank is likely to be extremely cautious about reading too much into the short term inflation data, which will be skewed for some months by unusual comparisons with periods of lockdown.
Another set of very distorted numbers were provided at the end of last week by Chinese GDP, which bounced back by an apparently very impressive 18.3% in the first quarter of the year compared with the same three months in 2020.
However, that period marked the low point of the pandemic in China and saw the economy contract by 7% year on year, the first decline in GDP in 40 years. So it was inevitable that there would be a big bounce this time. The quarter on quarter gain was almost non-existent and the longer term outlook is for a growth rate of about 6%, high by world standards but modest compared with China’s recent track record.
China is actually even further ahead in the post-pandemic recovery than the US and UK so it can be seen as a bit of canary in the coalmine. What is interesting about the Chinese response to the pandemic is how muted it has been compared with the ‘whatever it takes’ philosophy in the US. The Chinese authorities seem more interested in managing financial stability and reducing debts than in providing further stimulus.
That has had a knock-on impact on the stock market, which has fallen by around 15% since the middle of February. Exactly the kind of pause for breath that it might be sensible to prepare for in the buoyant markets on either side of the Atlantic.