The markets see the glass half full

Judging from the ongoing rally, spurred by encouraging economic indicators last week, stock markets were ignoring the persistent pandemic and growing political tensions.

The S&P500 index a whisker away from a new record high

By gaining 2% over the week, the Stoxx Europe 600 index recouped most of its losses from its correction in the previous week. The S&P500 and Nasdaq indices increased 2.5% on the back of excellent results published by the tech giants and hopes of a new incentive programme in the United States. In this year dominated by the Coronavirus, the Nasdaq does not seem willing to stop its race to post new records (+23% year-to-date). Meanwhile, the broader S&P500 index is also at a higher level than at the start of the year (+4%) and is now just 1% off its February record. Admittedly, this stock market rise is being driven by a handful of particularly high-performing stocks. On the other hand, 40% of US stocks are still at more than 20% off their individual record. And the Stoxx Europe 600 is 13% off its initial 2020 level.

Encouraging economic indicators

Last week, stock markets benefited from the support of encouraging economic indicators published for July. For example industrial business confidence rose more than expected to settle comfortably at above 50 points. As a reminder, this threshold represents the frontier between growth and an economic contraction, and has been crossed in China (52.8), Europe (51.8) and the United States (54.2). On the US employment market, 1.8 million new jobs were created in July. Although this is less than the sharp rise recorded in May and June, the  figure is higher than expected. Meanwhile, 42% of jobs lost in the wake of the Coronavirus crisis have since been recovered and the unemployment rate has fallen from a peak of 17% in March/April to 10.2%. Retail sales are obviously on the right track too. For example European car sales for July returned to last year’s level.

Rotation into cyclicals

These signals indicating a marked economic recovery mainly benefited cyclical sectors such as automotive, industrials and materials. In contrast, defensive sectors (food, household goods, health care, telecommunications and utilities) lagged. This pro-cyclical trend was also seen in the commodities market. Most industrial metals continued to rise, with the exception of copper. The price of oil also went up again after a few weeks of consolidation. But the steepest increases were observed on precious metals. The price of gold reached a new record high of more than USD 2,000, while the silver price continued its rapid catch-up movement with a weekly gain of +15%. This brings the total year-to-date rise to +57%. This flight to precious metals is the result of a combination of factors: money creation, negative real interest rates, recent dollar weakness and rising geopolitical tensions.

Company results not as bad as feared ...

Meanwhile, 85% of companies have already reported their results for the much feared lockdown quarter, and the damage is not as bad as feared: average quarterly earnings were down 36% in the United States (versus -45% expected) and -47% in Europe (analysts had feared -55%). Positive factors include the rapid recovery in June, China's contribution to growth and segments that benefited from the lockdown (online sales, digitalisation, medical apps, etc.) as well as the larger-than-expected cost savings, among other, due to furlough schemes.  For the full year, analysts are now forecasting average earnings to plummet by 20% in the US and by 30% in Europe.

... but the markets are turning a blind eye to geopolitical risks.

So far, the markets have chosen to ignore the second wave of Coronavirus contaminations in Europe, President Trump's political attacks on China and the absence of an agreement between Republicans and Democrats on a new incentive programme. Yet, time is running out, as several furlough/support income schemes and temporary tax cuts expired at the end of July. At three months to go before the presidential elections, both sides are uncompromising. The Republicans were considering an additional programme of USD 1,000 billion, but the Democrats are demanding new aid to the tune of USD 3,000 billion and are trying to seize the opportunity to push through some structural improvements in social security. Negotiations were extended again by a week. Meanwhile, Trump has already implemented a light, unilateral version. The question is whether this is executable, in view of the Democratic majority in Congress. This week will be exciting. And with the announcement of Jo Biden's running mate, the election campaign is picking up speed.

The technology war is escalating

The Cold War between the United States and China is escalating, and this time it is not about tariff barriers, but technological dominance. Claiming that China is taking personal data from American users, Donald Trump now wants to boycott Chinese apps TikTok and WeChat if they are not acquired by American companies within 45 days.  Furthermore, the US regulator is threating to remove the US stock market listing of Chinese technology giants if they fail to comply with the more rigorous disclosure and audit obligations. In other words, these threats do not bode well for the review of the 'Phase 1' trade agreement, scheduled for 15 August.

The economic recovery will not be a straight line

The markets seem to assume that the initially robust economic recovery seen in June and July (following the reopening of shops and factories) will continue in the coming quarters. However, the pace of the recovery could slacken, due to the resurgence of the pandemic, the still low level of activity in many service sectors, such as tourism and restaurants/cafés/hotels, and the risk of a rise in unemployment and bankruptcies. What has so far taken the shape of a ‘V’ curve is likely to become a ‘W’ or a square root (levelling out after an initially strong recovery). This prompts us to be cautious about the stock market in the autumn, but it is likely that the return of volatility will create new buying opportunities in anticipation of a gradual continuation of the economic recovery in the coming years.