The end of the rise?
Having recouped all of the year's losses on Monday, the S&P 500 index shed almost 6% on Thursday.
Last week, the S&P 500 index fell by 4.8% while the Stoxx Europe 600 index was down 5.7%. Note that in the previous week, these two indices had gained 4.9% and 7.1% respectively. What does this volatility mean? Is it the end of the rise?
For several weeks now, the divergence between the disastrous economic figures and the spectacular recovery in stock markets has been in the limelight.
The first week of June was marked by positive newsflow that fuelled renewed hopes of a rapid recovery. In terms of health, easing lockdown measures in Europe have not led to a spike in contaminations. On the contrary, the number of hospitalisations and deaths has continued to tail off. In terms of monetary policy, the ECB surprised positively by increasing its PEPP programme of bond purchases more than expected. On the fiscal front, Angela Merkel announced an additional €130 billion of stimulus measures and in the US, 2.5 million jobs were created while the economists' consensus forecast was a loss of 7.5 million.
Driven by technology stocks, the Nasdaq Composite index topped 10,000 for the first time ever and the S&P 500 returned to early-2020 levels.
There was a great deal of disappointment last Thursday, when it transpired that the number of new contaminations was rising again in some US states and the situation was worsening in Latin America. In addition, the Fed Chairman, Jerome Powell, was more pessimistic about the state of the US economy. That was enough to trigger a sell-off.
Should we fear another lockdown?
The massive protests that began in Minneapolis and spread around the world could accentuate the rate of infections. If this happens, the markets' reaction will depend on the response of political authorities. In the United States, new widespread lockdowns seem unlikely. The country seems to want to adopt the ‘Swedish model’ aimed at stemming the virus without implementing drastic lockdown measures.
This strategy is cheaper in economic terms, but could prolong the health crisis as seen in Sweden where the contamination rate has increased over the past two weeks.
The health situation in Continental Europe is improving, thereby allowing a further easing of health measures. Unfortunately, the situation in the United States and the worsening pandemic in countries such as Brazil, Mexico and India should prevent a recovery in air transport and international tourism. The recent rally in airlines, cruiseliners and tourism in general looks too premature.
Will the financial bubble burst?
The bullish trend in the American market has been much more impressive than elsewhere in the world. This is due to the technology giants and pharmaceuticals, which have appreciated considerably, making new historical records.
Can we expect the financial bubble to burst like in 2000? This is unlikely because the situation is very different in terms of cashflows and earnings. Moreover, these stocks appear to be the big winners of the health crisis. Their growth potential has grown because now that everyone recognises the merits of home-based work and leisure, investment in infrastructure and new online services will boom. As for biotechnology and health care, perhaps we are about to enter a new golden age.
This means that if there is a relapse, investors should be buyers of these sectors. Moreover, quality cyclical stocks have potential and do not have an over-valuation problem.
Many professional investors have been sceptical about the rise since March and have kept cash reserves.
A marked correction?
A lot of good news has been priced in by the markets. The stock markets have over-anticipated the timing of the economic recovery, which may lead to disappointments. A period of consolidation or even a correction would therefore be quite normal at this stage.
Is there a risk of a sharp fall? No one has a crystal ball and the risks are numerous, starting with a second wave of contagion, not to mention a possible escalation of US-Chinese tensions. So we can only reason in terms of probability.
There are a few arguments for a relatively modest correction in the immediate future. Economies were practically at a standstill, and are gradually restarting. Leading indicators are therefore likely to be positive in the coming weeks. It will be several months before we know whether the recovery is disappointing or not.
There is still some potentially good news about governments: the European Recovery Fund of €750 billion and the possible agreement between Democrats and Republicans on additional stimuli before the parliamentary recess in early July.
The impressive injections of liquidity by central banks and the considerable fiscal efforts should help the recovery. The beneficial effects of central bank policies are very apparent in the credit market. Companies are managing to raise significant capital in bond markets despite some notable bankruptcies.
As for geopolitical risks, one can hope (at best) that the approaching presidential election in November will make President Trump more cautious, because he really likes to highlight the successes of his economic policy by citing stock market performance.
Last week's volatility is a wake-up call to be cautious. The stock markets have most likely over-anticipated the timing of the economic recovery, which is likely to be only gradual. A pause is needed.
Taking profits on purchases made in March and April would not be a bad thing. On the contrary, this would help to build up a cash reserve to be used to capture dips.
But a too big a tactical move must not prevent investors from participating in the medium-term trend that is likely to remain positive. We remain confident in the recovery of economies thanks to the combined efforts of central banks and governments, which should allow earnings to recover.
More fundamentally, the post-Coronavirus period will be characterised by negative real rates (after inflation) which should be favourable to real assets such as equities, real estate and precious metals. The size of public debts will result in central banks and governments having a strong incentive to keep rates as low as possible for as long as possible. Cash and government bonds will not preserve the purchasing power of long-term savings.