From one drama to another

Social distancing meant that my family spent more time in front of the television than usual. My children and I would fight over the remote control, and we would eventually compromise and watch some classic basketball games, action movies or comedy shows. That meant we could be watching several genres of TV programs on any given day. The same could be true for investors in 2020. The first half was dominated by the COVID-19 pandemic and the dramatic market swings from one of the sharpest corrections in history to the most impressive rebound in half a century. This extreme volatility may not repeat in 2H 2020, especially given robust policy support from central banks and governments, but there are still plenty of opportunities for drama for investors to laugh or cry over.  

Rebounding from the lows

In last month’s Monthly Market Review, we compared the global economy to an athlete who had been seriously injured. The COVID-19 pandemic meant that many economic activities came to a standstill, and this was reflected by the plunge in production and service sector data, as well as the spike in unemployment rates in major economies. As the number of new infections declined in May and June, many economies are starting to reopen. Consumers and businesses are adapting to the new normal. The injured athlete is finally able to walk again. Economic data started to bottom out. June manufacturing Purchasing Managers’ Indices continued with their strong rebounds from the April lows. U.S. retail sales jumped 17.7% in May compared to April. Since the worst of the economic contraction is probably over, risk assets have rallied strongly in 2Q 2020. While U.S. equities led the rebound in April and May, improvement in risk sentiment has broadened to other markets, especially emerging markets. A weaker U.S. dollar also helped.

Even though this first stage of recovery is encouraging, for the athlete to return to full fitness to compete is going to take much longer. In early June, signs were starting to emerge that some of the southern states in the U.S. were seeing a surge in new cases. This has led some states, such as Texas, to pause their reopening plans. Meanwhile, Europe is preparing to reopen its borders for the summer holiday. The risk of another round of outbreaks is something that investors should be watching out for, and this fear has capped the momentum in the global equity market. 

From medical docuseries to political drama

The ongoing development of the COVID-19 pandemic will continue to drive market sentiment. A number of vaccines could move to the next phase of trial, and these results will be closely monitored. Still, we are some time away from a sustained solution being developed to cope with the virus. This means investors will start to focus on other factors driving the global economy.

The U.S. presidential and congressional elections on November 3 will be a key event to watch out for. Despite Joe Biden’s early lead in opinion polls, four months is still a very long time in politics. We will also be closely following whether the Democrats could capture the Senate. The elections could also influence U.S. President Donald Trump’s policies, including how he handles the U.S. relationship with China. Instead of broad tariffs, the Trump administration in recent months has focused more on limiting tech exports and financial decoupling in order to pressure Beijing. This perhaps reflects the administration’s concerns over tariffs’ economic impact. Overall, there is a market consensus that Washington’s hawkish position toward Beijing is unlikely to change regardless of who the next president is, even though the two candidates may approach dealing with China differently.

On top of elections, we will also be monitoring government and central bank policies. Many of the fiscal supports to households and businesses are scheduled to end in the summer. France and Spain have extended their crisis job schemes for two years and three months, respectively, to avoid mass unemployment. The U.S. Congress is also considering another round of fiscal stimulus to support the economy, but the challenge will be to gain bipartisan support. Overall, we would expect additional fiscal stimulus will still be needed around the world, but the re-opening of some businesses may reduce the scale of the stimulus package in some cases.

For central banks, low rates will stay for the foreseeable future. Not only are central bankers cautious over the pace of economic recovery, but also aggressive fiscal stimulus programs are prompting government bond purchases to maintain bond market liquidity. The pace of asset purchases may slow in the second half of the year, but the principle of keeping government and corporate bond markets stable is likely to stay. This need could be reinforced by a rise in corporate default, raising the risk of a liquidity crunch in the corporate debt market. 

Global economy:

• The June Purchasing Managers’ Indices for the U.S. and Europe continue to improve. U.S. retail sales data also showed significant improvement in May with a 17.7% increase versus April. However, the rebound progress has been thrown in doubt due to the rebound in infections in some states in the U.S., with the national daily infection number rising to 40,000. There are also concerns that another wave of outbreaks could come as European countries reopen their borders for the summer holiday.
  (GTMA P. 13, 25)
• China cut its policy rate by 25 basis points (bps) to support the economy. With industrial production up 4% in May, the Chinese economy is on track to return to year-on-year expansion in 2Q. In Europe and the UK, their central banks expanded their asset purchase programs in order to continue to fund government fiscal stimulus programs. France and Spain extended their job support schemes by two years and three months, respectively. The U.S. Congress is also expected to introduce another round of fiscal support for businesses and households, but this will require bipartisan support.
  (GTMA P. 9, 21)

Equities:

• After a strong rebound in April and May, the U.S. equity market took a pause with the S&P 500 up 1.5% in June. Worries over rich valuations and a rebound in infections are persuading investors to be patient. Yet, the tech sector continues to enjoy strong momentum given its resilience during the pandemic. NASDAQ was up 5.3% in the month. A softer U.S. dollar did help to lift international equities. The STOXX 50 was up 5% and the MSCI Asia index was up 7%.
  (GTMA P. 31, 32)
• In Asia, China’s CSI 300 gained 5% on the back of the ongoing economic recovery, despite a small outbreak in Beijing. India’s SENSEX was also up 5.1% despite a high number of new infections. Beyond Asia, key stock indices in Brazil, Turkey and South Africa all managed to gain more than 5% in June on the back of a weaker U.S. dollar and improvement in risk appetite.
  (GTMA P. 31, 37)

Fixed income:

• U.S. Treasury (UST) yields briefly pushed higher in early June on the back of better economic data and prospects of the economy reopening. Yet, the rebound in new infection numbers has pushed the 10-year UST yield back toward 65bps. The Federal Reserve’s commitment to low interest rates in the foreseeable future means that short-term interest rates are well anchored close to zero. The European Central Bank also pledged to keep policy rates stable and expanded its bond purchases by EUR 600billion, which helped to push European government bond yields lower.
  (GTMA P. 43, 46)
• Strong demand continued to compress high grade corporate credits in the U.S. with spreads narrowed by 22bps in the month. Meanwhile, high profile bankruptcies are raising concerns on high yield issuers, but with spreads widening toward the end of June, they still managed to stay flat for the month. A softer U.S. dollar benefited emerging market fixed income, but hard currency emerging market debt (EMD) outperformed local currency EMD. A strong risk appetite has also led to high yield bonds outperforming investment-grade bonds, both in government bonds and corporate debt.
  (GTMA P. 45, 51, 53, 54)

Other assets:

• Oil has rebounded back to USD 35 per barrel (pb) (for West Texas Oil) and hovered around USD 40pb (for Brent) as oversupply remained a concern despite producers’ commitment to keep production at a reduced level. In the long run, investors are questioning whether the cutback in energy-related investment could push oil prices significantly higher once the economic recovery is underway. Yet, this is unlikely to be a concern since oil demand from transportation is expected to stay weak in the months ahead. Gold pushed a little higher toward USD 1785 per ounce as yields fell on the back of fears of a second wave of infections in the U.S. This may push above USD 1800 per ounce if risk appetite weakens again or if government bond yields push lower.
  (GTMA P. 62, 63, 64)