It doesn’t take much to nourish bullish sentiment at the moment. Evidence of a slowing downturn across the eurozone — activity continues to contract — leaves share prices flashing green across trading screens.
It is another example of how the direction of travel, rather than evidence of a sustained economic recovery, currently bolsters market sentiment in a financial system flooded with cheap money.
The latest global investment view from Amundi notes:
“Current valuations are the result of a liquidity-driven rally and are being sustained in the short term only thanks to the continued aggressive monetary expansion.”
Wall Street has picked up the baton from Europe, with record highs for Apple, Amazon, Netflix and the Nasdaq. In an uncertain macro climate, big tech holds plenty of allure. Gold has popped above $1,780 an ounce — a fresh high since October 2012 — driven by a weakening dollar. Hardly a surprise given the monetary largesse of central banks, led by the Federal Reserve. And yet there are doubters as to whether a genuine reflation trade is sustainable.
The truth of the matter is that any bounce from shutdowns is going to look good, given depressed levels of activity. A key aspect of the coming recovery is whether the bounce in the next few months is sustained and soaks up enough unemployed workers.
A market recovery trade reflects a number of elements, or what JPMorgan’s John Normand says includes “strong data momentum, loose policy, cheap valuations and defensive investor positioning”.
Data momentum is picking up from a low base, fiscal and monetary policy in full expansion mode, while plenty of cash sitting on the sidelines is shifting to new destinations, but as John writes:
“Valuations are no longer cheap in most major markets, with some asset classes pricing in very normal growth recovery rather than a constrained one.”
“Credit & equity have overshot mildly if the next expansion is as vigorous as most previous ones, and have overshot considerably if expansion resembles the post-GFC one.”
Perhaps that explains the divergence between what investors are saying — via the America Association of Individual Investors survey — and actually doing when looking at US equities.
Citi’s equity strategist team, led by Tobias Levkovich, highlights via this chart:
“A meaningful divergence though has emerged between AAII bear results and put/call ratios for the first time in a long while.”
Bearish sentiment among investors is rising while a falling ratio between put and call options on equities as shown here, means the market is betting more heavily on higher share prices in the future.
“We suspect that too many fund managers do not want to miss the next possible Fed-induced S&P 500 advance, but now is not the time for such bravery, in our opinion.”
Indeed, Amundi warn during the second half of the year, “a reality check on earnings growth has to be considered”.
Over at RBC Capital Markets, Lori Calvasina thinks analyst expectations for earnings in 2021 “are too high” with a call for “S&P 500 EPS to come in at $163 in 2021 — right back to 2018-2019 levels, and well above our own model which anticipates $149”.
That places quite an onus on the next round of earnings calls with companies when the current quarter results start unfolding during July. Lori is keeping an open mind and adds:
“If we find reason to become more optimistic about 2021 EPS in the upcoming reporting season, we’d consider becoming more constructive on the stock market.”
A key factor supporting expectations of a pronounced economic rebound is the prospect of pent-up demand from shutdowns being released. For those able to work at home and still being paid, lockdown life has certainly bolstered saving rates.
Analysts at BCA Research caution:
“Pent-up demand is a finite source spending and it will be satiated. As a result, a strong recovery in Q3 and potentially Q4 will probably ebb in 2021, especially as the US fiscal thrust will become somewhat of a headwind next year.”
That may clip the recovery story in corporate earnings and that’s before assessing what the US elections in November entail for company tax rates.
BCA are sticking with an upbeat tone and think that even with some reduction in spending next year, “growth will remain above trend in 2021 as the recovering labour market will continue to boost household confidence, which creates a downward pull on the household savings rate”.
The last word rests with Amundi and they artfully suggest a portfolio mix that can benefit from either reflation or a bumper recovery. This takes the form of retaining liquid assets “as a second leg-down in the market can’t be ruled out” while also having “some exposure to cyclical assets that offer high performance potential in the event that a favourable scenario plays out”.
Quick Hits — What’s on the markets radar?
In raw terms, the composite purchasing managers’ index for the eurozone was 47.5 in June, up from 31.9 in May. A reading below 50 indicates that a majority of businesses in the survey reported a contraction in activity compared with the previous month.
Economists at Nomura highlight that while PMIs beat forecasts, the latest figures “still point to a slow economic recovery” and note a pronounced relationship among data for the euro area, Germany, France and UK:
“The larger the fall during the lockdown, the steeper the subsequent rise.”
Economists at RBC Europe believe “rebounds in the PMI surveys, at this stage of the recovery, are just a function of easing in lockdown measures” and they add:
“PMIs will only begin to reflect and hence inform us on how underlying demand is recovering once the easing of lockdown restrictions plateaux.”
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