#Articles — 28.07.2020

Profit-taking on growth stocks, gold at a record high

Patrick Casselman, Investment Advisor

Equity markets lost ground over the week as the good news about the European Recovery Fund was overshadowed by the upsurge in both the Coronavirus pandemic and political tensions between China and the US.


The S&P500 index dipped (-0.3%), but the correction was somewhat larger (-1.5%) on the Nasdaq, the Stoxx Europe 600 and the Hong Kong stock exchange. Growth stocks that had already posted a decent rise, namely in the technology and health care sectors, were particularly targeted for profit-taking. The agreement reached on the European Recovery Fund led to a strengthening of the euro against the dollar and a fall in interest rates on Southern European bonds. The weakening dollar and rising geopolitical tensions helped the price of precious metals (e.g. gold and silver) to soar.


The agreement on the European Recovery Fund...


However, last week got off to a good start with a political agreement on the European budget for the next 7 years (EUR 1,074 billion) and the European Recovery Fund (EUR 750 billion). Countries that support austerity (Netherlands, Sweden, Denmark and Austria) negotiated and obtained a reduction in the amount of subsidies (from EUR 500 billion to EUR 390 billion) that would be granted to countries that have been badly affected by the Coronavirus pandemic (mainly Southern European countries). But this agreement remains an historical breakthrough. In total, the incentive programme represents 4.7% of GDP, and it paves the way for a joint issuance of Eurobonds, and consequently, ushers in a real European solidarity.


These Eurobonds should eventually be reimbursed with the revenue of new European taxes such as a "digitax" (on the turnover of internet giants), environmental taxes on plastic or a tax on CO2 emissions for imported steel. In terms of allocating resources, a substantial share will be earmarked to ecological investments, for example in favour of the energy transition. Note, however, that the recovery fund must still be approved by the various national parliaments.


... and other encouraging news...


The PMI indicator reflecting the confidence of European entrepreneurs rose by more than expected in July, from 48.5 to 54.8 points. It thus reached, for the first time in a long time, a level well above the 50-point threshold, indicating a meritorious recovery from the particularly low levels of activity in April and May. In the United States, the rise in this purchasing managers' index was slightly less convincing: from 48 to 50 points.


In terms of company results, so far, publications have exceeded expectations. In Europe, companies such as Philips, Daimler, STM and Unilever beat forecasts thanks to a rapid recovery in June, while some segments took advantage of Coronavirus treatments or lockdowns, as well as successful cost savings. There were also disappointments, however, at Intel and Netflix, among other. And despite an upward revision in analyst forecasts, average earnings per share are still expected to fall in the second quarter by 43% in the US and 49% in Europe.


There is plenty of encouraging news about new vaccines.  After Moderna the previous week, AstraZeneca and Pfizer reported encouraging interim results and announced that their respective vaccines were entering the final test phase.   


... overshadowed by a resurgence in both the virus and geopolitical tensions


The slight correction that equity markets posted was mainly due to the resurgence of the pandemic in several countries, a situation likely to hamper the recovery in the second half of the year. In the US, consumer confidence is already pulling back this month (after the recovery in May and June), and the number of weekly jobless claims has climbed again. Republicans and Democrats have still not reached an agreement on the concrete content of the next stimulus programme. Moreover, if no agreement is reached, various temporary tax allowances and cuts will expire at the end of the month.


As if this were not enough, the Cold War between the United States and China is coming back to the fore too. Not about tariff barriers, this time, but rather about the power exercised over Hong Kong and accusations of intellectual property theft. It was in light of this argument that the US authorities decided to close down the Chinese consulate in Houston. China retaliated by ordering the closure of an American consulate in the city of Chengdu. Donald Trump is also considering limiting Chinese companies' access to the US capital market. These measures aimed at China appear to be an integral part of the US election campaign and could therefore persist until the election in November. Brexit talks (about a new UK-EU trade deal) are not making progress and could make for a turbulent autumn.


The dollar weakens and gold hits a record high


The agreement reached on the European Recovery Fund and the weakening of US economic indicators led to a sharp decline in the dollar against the euro and most other currencies. In return, precious metal prices are rising. Meanwhile, the price of gold reached USD 1,900, in line with its 2011 record. That said, it was mainly the price of silver that has seen a vigorous catch-up movement in recent weeks. Central bank liquidity injections and negative real interest rates are boosting demand for real assets, and a surge in both the pandemic and geopolitical risks is causing a flight to safe havens such as precious metals.


This week’s highlights will be the second quarter earnings season, with in particular, the updates of a few tech giants, such as Apple, Amazon, Alphabet and Facebook. Will these numbers live up to the already substantial rise in share prices, or are we going to see a “sell on the news” reaction as observed recently for Tesla? Also we await the publication of second quarter GDP, which will undoubtedly reveal the largest quarterly contraction in several decades.