A rising count of Covid-19 infections is chipping away at the resilience among investors. Flat equities are accompanied by a firmer US dollar and modest gains for sovereign bonds.
These market shifts remain within recent ranges and unless a dreaded second wave accrues further momentum in Beijing, the US and now Germany, declining risk appetite should soon find buyers. This reflects a couple of factors. First, economic data are surprising to the upside with measures from Citi holding at recent highs for the US and globally.
Analysts at Citi say:
“The major drivers for risk assets continue to be positive economic surprises, a backdrop of easy money/ loose monetary conditions, and high cash balances/ low positioning. All of these factors in unison remain supportive of buying dips.”
Or as the strategists at CrossBorder Capital bluntly describe the present situation:
“Markets follow money.”
This is highlighted below in the chart (Fig 4) that shows global liquidity — spurred by expanding central bank balance sheets — triggers a sharp appreciation in asset values and CBC says:
“Unquestionably, the picture may not prove as smooth as the 20-year chart suggests, but the historical evidence remains compelling.”
With global central banks pushing the envelope, CBC expect “an increase in global liquidity of around 25 per cent for 2020, as a whole”, and they add:
“Latest data put the stock of world financial assets at US$231.7tn and, set against a prospective year-end global liquidity pool of more than US$160tn, gives a ratio of 1.45 times.”
So what does that mean?
As shown above (Fig 5) the long term average of this ratio is 1.75 times, “which leaves substantial scope for further capital gains”.
CBC only expect a year-end ratio around 1.66 times, reflecting bigger sales of Treasury debt resulting in higher funding pressures, while “excess cash is run down to pay-off past debts”. That still leaves plenty of global liquidity in the system that can push asset values higher.
Ultimately, CrossBorder Capital expect:
“These inflows to move through the markets and spread out into the wider economy over time, with gathering risks, in our view, that high street inflation will stir by mid-2021.”
Unlike the general response in the wake of the financial crisis — where interest rates were slashed and quantitative easing accelerated — this time there is a hefty fiscal stimulus.
Over at Goldman Sachs, the portfolio strategy team led by Peter Oppenheimer believe the next business cycle should rhyme with that of the past decade, whereby:
“Growth companies will continue to prosper. Sustainable dividend payers will prosper” and “debt levels will be higher: strong balance sheet companies will prosper”.
One interesting observation is that in a world where leading 10-year sovereign yields loiter around zero, equities are “less likely to be driven by valuation expansion” from falling benchmark rates and Goldman observe:
“With interest rates now at the effective lower bound and with room for yield curves to steepen as term premia recover, it is less likely that growth companies will outperform on the basis of widening valuation spreads alone.”
Now Goldman are willing to consider a different outcome for the coming cycle and they note a combination of extended QE, zero interest rates and “significant fiscal expansion” stands to change the outlook:
“If the fiscal spending feeds into physical infrastructure projects, it could lead to a rise in inflation in the real economy.”
Whether that resonates beyond companies with secular growth stories such as tech, will also depend on just what kind of economy ensues in the next cycle. Plenty of consolidation and failures across mature industries into 2021 will lay the ground for the survivors benefiting from less competition and enjoying better profit margins. This may well loom for sectors such as oil, autos, airlines and retailers and Goldman adds:
“A trend towards localisation and diversification of supply chains may also work in this direction, reducing competition for companies in the more mature industries within the developed economies.”
Quick Hits — What’s on the markets radar?
Shares in Wirecard closed lower by nearly 70 per cent and its bonds were also hit hard, after the German fintech company disclosed that auditors at EY could not confirm the existence of €1.9bn in cash. Ouch and kudos to Dan McCrum and other FT reporters for their lengthy investigation of accounting allegations against Wirecard, while encountering plenty of resistance. Very much a case of living up to the FT’s motto: “Without fear and without favour”.
The Bank of England met market expectations with a £100bn boost in its quantitative easing bond-buying programme to a total of £745bn that nudged Gilt yields higher, while the pound remained under pressure, falling towards £1.2420 — from about £1.2560 earlier.
Seema Shah at Principal Global Investors says this will allow the bank to soak up Gilts through July and paves the way for an extension being announced at the monetary policy committee meeting in August.
“Indeed, the government borrowing requirements suggest that the Bank of England will need to up its purchases if it wants to avoid a sharp spike in bond yields.”
As for sterling, which has taken a hit from chatter of negative interest rate policy and a risk that the UK leaves the EU without a trade deal, Dean Turner at UBS Wealth Management says:
“Concerns around the potential for negative interest rates, and more recently Brexit, are overdone” and they expect a stronger pound “against the weakening dollar as the year progresses”.
Neil Williams at Federated Hermes thinks the prospect of a negative overnight rates policy looks like a “red herring” for markets and says:
“We calculate the BoE is running a true policy rate as low as -6 per cent, or -8 per cent in real (inflation-adjusted) terms, when QE is fully taken into account. Together with other emergency measures, this confirms by far the loosest monetary-and-fiscal stance in 30 years of data, probably postwar, with little correction in 2021.”
In a busy day for central banks, Norway (the Norges Bank) and Switzerland (the SNB) maintained their current monetary policy stances and Stephen Gallo at BMO Capital Markets believes:
“Neither central bank will be comfortable with prolonged strength in their local currencies.”
Market Forces is taking a short break and will return on Monday.
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