Summer rally and sector rotation

Mid-week the summer rally accelerated thanks to a reduced number of Coronavirus contaminations in the US and clear signals of an economic recovery (an improvement in business confidence, industrial production, auto sales, consumer spending, etc.). Also, investors are still hoping for vaccines, and new incentives from the US authorities. The absence of an agreement on the latter, however, fuelled concerns towards the end of the week. In addition, the increasing number of quarantine measures decreed between European countries reminded us that the pandemic is still raging.

The S&P500 tests a record high

Every day last week, the S&P500 index tried to beat its February record but each time it ended the session just short of this level. For the week as a whole, the S&P500 edged up by 0.6%. In any case, a remarkable difference was observed between the Dow Jones (+1.8%), comprising traditional sectors, and the Nasdaq, representing growth stocks, which closed the week flat following a few days of correction.  

Sector rotation from growth stocks into cyclicals

Despite the European stock markets correcting on Friday, the Stoxx Europe 600 still gained 1.2% on a weekly basis. Stock markets in southern Europe rose by nearly 3%. A similar result for most Asian equity markets. Sector-wise we have been seeing a noticeable catch-up movement from cyclical sectors with cheap valuations, such as automakers, banks, energy, etc. Sectors that had previously posted vigorous rises (e.g. technology, health care, etc.) were the targets of profit- taking last week.

Bond yields rise

After having stagnated for several weeks at around their recent low (0.5% for the US treasury 10-year rate and -0.5% for the German bund), bond yields finally surged, for the first time in a while. The German rate became less negative (-0.4%) and the US rate rose to 0.7%. Although interest rates are still low, this marks a striking increase that may suggest that the economy is recovering, but it could also be linked to rising inflationary expectations. 

Although inflation is set to remain low in today's challenging economic climate - characterised by underused capacity and high unemployment - the huge monetary and budgetary incentives are likely to cause a surge in inflation eventually.  Both China and the US published last week higher-than-expected inflation rates for July. The increase in retail prices from their pre-Coronavirus crisis level is primarily due to fewer sales promotions and price competition in a business environment hurt by the Coronavirus.       

A correction in gold 

In commodity markets, most industrial metals and energy prices rose on the back of cyclical optimism and falling inventories. On the other hand, precious metals such as gold and silver, were the target of sudden profit-taking after their vertiginous rise in previous weeks. Rising interest rates may have contributed to this movement.  

Political gridlock

In the US, the Republicans and Democrats have still not managed to agree on a new stimulus programme. Even after President Trump's unilateral decision to extend emergency aid to the unemployed, students and tenants, the markets have not given up hope of a more comprehensive deal. The President of the Senate hinted that this agreement may not materialise- or anyway not before the end of the parliamentary recess (9 September).

The interim review of the Phase 1 US-China trade agreement, initially planned for 15 August, was postponed. No reason was given but perhaps China must first catch up with imports of American agricultural and energy products. Meanwhile, Donald Trump continues to fuel tensions with China by threatening to boycott Chinese apps TikTok and WeChat. And with regards to Europe and Canada, he has a tough stance on customs barriers. No doubt, this intransigence must be considered as an electoral strategy.

After Kamala Harris was appointed Joe Biden's running mate, and ahead of the Democratic convention taking place this week, attention is likely to shift to the electoral battle.