WeeklyWatch – Bouncing markets indicate the beginning of the end – but they may fall again

12 May 2020

Stock Take

During the early days and weeks of the virus outbreak, many governments worldwide enjoyed a surge in popularity – the need to rally behind leaders benefitted incumbent politicians. From the UK government seeing its best popularity in decades to Italy’s prime minister’s stunning 71% approval, it was Angela Merkel’s 79% that bested them all. Of course, this may reflect European Central Bank policies along with domestic policies, although ECB bond-buying plans face a new hurdle, as of last week.

“Under the leadership of Christine Lagarde, the European Central Bank has been much bolder and has moved much faster than we have seen in prior crises,” said Michael Power of Ninety One (formerly Investec). “However, Germany’s constitutional court has thrown a spanner in the works by referring the ECB’s planned bond-buying activities to the European Court of Justice. These are extremely serious matters for the eurozone. If they are not resolved in a way which allows the ECB’s stimulus to proceed, I believe an Italian exit from the block becomes a higher probability.”

EU sales suffered their largest monthly dip on record – 11.2% lower in March than February, and the Euro STOXX 50 had a bad week. The EU also faced pressure from the US and Australia to support the launch of an independent inquiry into the origins of COVID-19. Last week, it became clear how far US-China relationships had deteriorated in recent weeks as Mike Pompeo, the US secretary of state, claimed there is significant evidence linking the virus’s outbreak to a government lab in Wuhan. US officials said on Friday that trade talks continue.

Plunging jobs

The Whitehouse has no shortage of worries at the moment, after a US payrolls report last Friday showed the loss of 20.5 million jobs in April – this came after the ADP private sector report showed that nearly a decade of jobs gains had been wiped out in less than two months.

While the pandemic has cut across global supply chains and knocked customer spending, the US trade deficit has suffered accordingly, widening by 11.6% in March. And as global trade continues to deteriorate, exports have reached their lowest level since November 2016. US Purchasing Managers’ Indices for both manufacturing and services were far down in the mid-20s (where 50 indicates no change), while consensus forecasts now point to a U-shaped, rather than V-shaped, US recovery. All this is likely to have implications for the president’s ratings, and therefore his electoral prospects.

“The slow recovery will make it much harder for Trump to win a second term in office, which is one of the reasons he is pushing for an early re-opening of the US economy,” said Power. “Meanwhile, anti-China rhetoric is rising. This appears ill-advised, because the US imports a substantial proportion of its medical equipment from China.”

A huge spike in borrowing is expected from the US Treasury, with the government likely to raise $4.5 trillion this fiscal year. Of course, this will also affect markets and as things stand, bonds and equities look to be headed in opposite directions. Bond investors may be worrying about debt levels, but equity investors are hoping for growth. The S&P 500 rose significantly last week.

Popularity falls

In comparison to Brazil however, Trump’s prospects are bright; Jair Bolsonaro saw his ratings drop to the lowest of his presidency last week, with just 27% saying he’s doing a good or great job, and 49% saying he’s doing a terrible job. Last week as well, a forecast from Société Générale suggests Brazil’s economy will contract 7.4% in 2020.

The Bovespa, Brazil’s leading stock index, is down more than 30% for the year, however this reflects a broader Latin American story; mixed results on virus containment and plunging commodity prices weigh on sentiment.

As much as you can still include China in the ‘emerging markets’ bracket, it is proving an exception to falls across the board. While the services sector contracted (on a monthly basis) further in April, the rate of that contraction has slowed since March. Meanwhile, exports increased, and trade surplus climbed last month. However, a fall in revenue means the fiscal deficit likely ballooned in April; the CSI 300 rose last week, but there are now signs of a second spike in virus cases in China.

“Sentiment in China is actually pretty good – the Shanghai market is only down 9% in US dollars year to date, partly because it was the first country in and will be first out,” said Alistair Thompson of FSSA, manager of the St. James’s Place Asia Pacific fund. “Interest in autos is strong, probably because social distancing is expected to be around for some time, so people are avoiding public transport. And the supply side looks like it’s back on its feet, although the demand side is much more questionable, when most of the world is still in lockdown. If borders don’t open, trade and business will be limited for some time. But we’ve always preferred consumer staples because the sector is less volatile and cyclical.”

In the UK, early trading this week showed investors responding positively on the FTSE 100 after Sunday’s confirmed (mild) easing of lockdown measures. The Monetary Policy Committee also implied that more quantitative easing is to come, and with Brexit firmly out of the public eye, trade talks with the US were formally launched and reportedly began on good terms. The government has also been testing a contact-tracing app on the Isle of Wight.

The Bank of England offered plenty to ruminate on, however, when it forecast that the UK was due to suffer its worst recession in 300 years.

Wealth Check

There’s no denying that investors have been on a rollercoaster since pandemic fears hit the market in February. The US stock market fell at the fastest rate on record – more than 30% in just 25 trading days. In the Great Depression, it took nearly twice as long to fall that far.1

But what’s been just as remarkable is the rally that’s been seen since the market troughed on 23rd March. The Dow Jones index – which covers the 30 largest US stocks – was at once stage up almost 30% from that low. And some of the biggest companies in the world are back trading at all-time highs. The FTSE 100, in comparison, is up around 19% from its low.2

The primary concern will of course be the devasting health impact that coronavirus has had, but could the recovery seen in markets mean that the worst is over for investors? Have we finally turned a corner?

Analysis of historic crashes and their aftermath suggests that there is a good chance the lows of March will be tested again in the months to come.

Looking at daily price movement data for the Dow Jones index from the last 135 years, Schroders have analysed previous episodes when the index fell at least 25%. In 11 of 13 occasions, the market rebounded at least 10% on the way to bottoming out.3 This shows us that there is usually a false dawn, somewhat grimly known as a ‘dead cat bounce’. In fact, on average, the market bounced three times during big market downturns.

Source: Financial Express; data shown for Dow Jones Industrial Average and FTSE 100 Total Return indices. Past performance is not a guide to future returns.

So given that market bounces are a feature of corrections, what does the current rebound mean? Well, given the unprecedented speed of the decline, a huge amount of pessimism included; this means that the slightest sign of things getting better was enough to trigger a recovery. This sign was a slowdown of case numbers in Europe, which was taken as a possible direction for elsewhere, too.

The future path of the virus and its impact on economies and financial markets is still unknown, and there is concern that the hit to corporate earnings is not yet reflected in stock prices. That realisation could be one of the catalysts for markets to fall again before we’re able to see sustainable improvement.

The idea of future falls may not be a happy one, but it is realistic. Investors who have been able to sit tight should continue to do so, remembering that their long-term financial goals are years, not months, away. And for those thinking about investing, it’s worth iterating that it’s ‘time in the market, not timing in the market’ that produces the best results. Trying to predict when the market has reached its floor is impossible.

1.3 Schroders, April 2020
2 Financial Express, May 2020

The value of an investment with St. James’s Place or Wellesley Wealth Advisory will be directly linked to the performance of the funds you select, and the value can therefore go down as well as up. You may get back less than you invested.

In the picture

Asia’s middle class has been one of the economic miracle stories of recent decades. It is a story with many chapters left.

The Last Word

“We kept faith that the cause was right – and this belief, as my father noted in his broadcast, carried us through. Never give up, never despair – that was the message of VE Day.”

– Queen Elizabeth II, speaking in her VE Day address.

FSSA and Ninety One are fund managers for St. James’s Place.

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