Fixed income
- This week initially saw a reversal of fortunes, with risk markets rallying after last week. Equities were stronger and credit spreads a little tighter, though this mini rally tapered off towards the end of the week.
- Implied five-year default rates as of 19 June: Euro IG = 5.6% and Euro HY = 28%.
- US retail sales are up 18% month-on-month, which was much better than the expected 8%, led by auto sales, while US industrial production was up 1.4% month-on-month. The weekly US jobless claims (as of 18 June), however, didn’t fall as much as expected.
- We’ve seen rising geopolitical tensions, for example between India and China, and between North Korea and South Korea.
- We’ve also seen rising cases of Covid-19 in southern US states – Texas, California, and Florida – seemingly without much of a response plan.
- UK inflation this week fell to its lowest since 2016 (0.5% year-on-year), and the Bank of England announced an additional £100 billion of stimulus. UK retail sales, meanwhile, jumped by 12% month-on-month (double the expected 6%).
Us equities
Markets
- US equities fell sharply last week after three straight weeks of gains; the S&P 500 falling by 4.8% and the Russell 2000 falling by 7.9%. The value/cyclical rally which we have seen in recent weeks lost ground, while growth/momentum factors held up better in the sell-off.
- Growth and momentum sectors resumed their market leadership, with technology and communication services faring best. At the other end energy, financials and industrials were the worst performers following a good run.
- The main factors driving the move seem to have been fears of a second wave of infection as Covid-19-related cases and hospitalisations ticked up in some areas, as well as some general consolidation after strong recent performance.
- This consolidation follows a period where stocks have partly been pushed higher by retail investors looking to join the market rally, emboldened by the Federal Reserve’s action to shore up the market. This increased market participation has also displayed some signs of speculative investing in companies with poor balance sheets, car rental firm Hertz being the notable example. Despite having filed for bankruptcy the firm’s shares were bid higher by speculation which prompted it to launch an opportunistic $1 billion share sale to take advantage of demand for its shares and help to pay its creditors during bankruptcy proceedings.
- The Fed gave a dovish update following its policy meeting, announcing that it is “not even thinking about raising rates” and expect to keep them at the zero bound through until at least 2022, while keeping up its asset purchase programmes. However, the market did react more negatively to the Fed’s more cautious outlook for the economy’s recovery. businesses.
Economy
- Economic data continued to paint a picture of slowly improving conditions and a further move off the bottom, particularly on the auto side. Auto sales data for the third week in June showed a year-on-year decline of only 10%. Railroad volumes are also pointing to recovery; auto shipments by rail are now down by about 40% year-on-year compared to roughly 95% down at the worst point of the crisis. However, it is not a uniform recovery as coal shipments by rail have not improved by as much, which is most likely due to lower industrial demand and low gas prices.
- We expect to see a more natural recovery in the auto sector where end market demand should get back to its original levels. By contrast, we have less confidence in the route back to normality for airlines as the demand assumptions for that sector are more likely to be permanently damaged.
- Republicans are reluctant to renew the unemployment benefit programme beyond July, and so there could be implications down the line for employment.
Election
- Whereas a few weeks ago it looked like the chance of either a Joe Biden or Donald Trump victory in the Presidential election was roughly 50-50, the polls have now swung in Biden’s favour, with around a 60% he will take office. The possibility of a Democrat takeover of the Senate is also gathering pace, which could lead to increased regulation and a (partial) reversal of the Trump tax reforms. Trump’s handling of the coronavirus crisis and more recently the race-related protests have been factors in his deterioration in the polls.
European equities
- Markets have veered between optimism that lockdowns are finishing, and pessimism that the US and China (in the latter case a second wave) are seeing more fatalities and infections. The UK government appears beset by issues surrounding unwanted quarantine and distancing, coupled with stalled Brexit negotiations.
- The outlook for companies still seems to be running at varying speeds. Some are seeing strong trading as markets reopen, while others are benefiting from changing environments – the boost to online trading, or frenetic investment in vaccines, tests and treatments for the virus.
- We have been taking profits in stocks where valuations have become unrealistic, bearing in mind that markets have run hard since the nadir of late March, boosted by the attractions of low interest rates.
- We are mindful to ensure portfolios are not one-sided – some cyclicals will survive and may thrive, winning market share as their more challenged competitors with more fragile brands, technologies or capital structures suffer; but they may be too cheap as the immediate operating outlook is tough. So while we continue to have a quality bias, we are active in ensuring portfolios are well positioned for the current market circumstances and are aware of the risks of a value rally or dash-for-trash, such as seen in the past few weeks – a parallel of 2016 and 2018.
Japanese equities
- It’s been a mixed week for the asset class with initial concerns on the increase in virus infections globally, as value cyclicals witnessed heavy profit taking. This was shortly followed by a new stimulus pledge from the US Federal Reserve which lifted both Japanese and global markets.
- Domestically, the number of new cases edged slightly higher – cases in Tokyo rose to 48 on Monday. This has not come as too much of a surprise given lockdown has come to an end in Japan, while a more severe spike would be required to trigger a new lockdown.
- Nihon M&A Center has reported a surge in mergers and acquisitions interest in Japan since the Covid-19 outbreak. Despite the pressure companies will face in the short term, we expect an acceleration in industry consolidation over the long term, which can lead to higher returns on capital – a positive for shareholders.
Multi-asset
- Notwithstanding some recent weakness, punchy asset market rebounds since March have, to a degree, dented the valuation case for risk assets. Furthermore, economic data remains extremely weak.
- Yet, insofar as what matters for asset markets is how the world evolves in 2021 and beyond, three factors lead us to keep broad allocations and risk views unchanged:
- Policy support Both monetary and fiscal continue to run/grow at an unprecedented size and speed. Low growth, low inflation and lower discount rates should prove a powerful support to valuations and we are keen to be long assets most impacted by the policy response.
- Positioning While investor positions have built up since the March shakeout, there is a lot of room for further increases, with allocations to equities, for example, at the low-end of the post-global financial crisis (GFC) period.
- New beginnings Covid-19 has brought forward the recession that many were expecting given the longevity of the post-GFC cycle. As economies reset in early stages of recovery, higher multiples might be expected.
- However, while acknowledging that companies will be in worse shape after the crisis than before, we keep our preference for quality risk.
