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Recent elevated daily swings in global equities suggest a range bound summer beckons. Sharp drops have been followed by impressive bounces that preserve much of the big gains from the lows of March.

This tug of war reflects a contest between forward looking equity sentiment and the unknown aspects of how Covid-19 ultimately influences the reopening of economies in the coming months.

For now, renewed bouts of coronavirus in China and the US are seen being contained events. That entails clipping, rather than derailing, the reopening trade that until last week was the big driver of global equity performance.

Over the past month, financials, industrials, real estate, energy and materials top the list of leading MSCI Global Equity sectors. Narrow that lens to just the past week, and these groups are laggards in performance terms. This story is replicated by the Stoxx 600 and the S&P 500 — shown below — when looking at a one-month and five-day performance stance.

Spine chart showing S&P 500 percentage returns by sector for the last week and the past month

Given the extent of the rebound in broad terms from the market lows of March, plenty of good news is already reflected in the current level of asset prices.

A backdrop of substantial monetary and fiscal support also extends a floor for risky assets, that limits pullbacks. This aspect has notably helped equities look past new cases of Covid-19 in recent days with a switch in market leadership.

Column chart of MSCI All Country World index , daily % change showing Global stocks have recovered some of last week's losses

But another substantial leg higher in equities looks challenging and BCA Research expect “a stock market that churns for the bulk of the summer” while better economic figures are seen pressuring government bond prices. This is already emerging among long-dated US Treasuries. The US 30-year bond yield is some 30 basis points above its lows of April, whereas the 10-year note has only risen by half that amount.

Volatile swings for equities are not going to fade argue analysts at Bank of America. They describe sentiment in equity markets as one of being “comfortably numb” whereby they are vulnerable to sudden bouts of turmoil, should bad news cut across the general forecast of a rapid recovery.

“The challenge with a market propped up on the promise of policy and divorced from fundamentals is it leaves investors with low conviction. Many get forced into chasing the trend against their better judgment” and this creates an environment “that markets are riskier than they appear”. 

BofA says of the upshot from pullbacks in equities:

“To many, it will seem like a great buy-the-dip opportunity, but the risk is that it’s only reloading the spring for the next fragility event and the potential for a more major trend reversal.”

Playing an important role in driving market sentiment is that of positioning. Global market strategists at JPMorgan believe that shot covering alongside declining volatility and central bank infusions of liquidity explain much of the rebound in equities since late March. JPM show here, a proxy of short interest — the quantity on loan, across stocks and equity ETFs globally, and conclude that about two-thirds of the $500bn short base that ensued during February and March, “has been unwound so far”.

Quantity on loan on stocks and equity ETFs globally

One interesting regional breakdown of short interest implies “that most of the remaining short base in individual stocks is concentrated across non-US equities” according to JPMorgan:

“There is still large short base across European stocks with less than a third of the previous short base that had opened up on euro area and UK stocks during Feb/Mar having been unwound so far.”

That potentially lays the ground for Europe and the UK catching up a little more with the US. The FTSE All World index (excluding the S&P 500) sits 11 per cent lower on the year. Once the S&P is added, that loss narrows to one of minus 6.4 per cent.

Ultimately, monetary and fiscal support only bridges the gap to what kind of economy beckons from here. Paul O’Connor at Janus Henderson says:

“Policy interventions on both the monetary and fiscal fronts have successfully cushioned financial markets from the impact of the economic slump so far but neither central banks nor governments seem capable of altering the fact that coronavirus is likely to be the dominant factor defining the shape of the economic recovery beyond the reopening rebound.”

And in that respect there is one area of concern argues Johannes Müller, head of macro research at DWS:

“During a typical downturn, relatively lower-paid service-sector jobs, such as those in hospitality and retail, tend to soak up some of those entering the job market, or those whose skills are no longer in demand. In the current slump, these types of jobs are unlikely to fully return any time soon, let alone offer employment for those laid off by other sectors.”

Hardly conducive for healing social and economic inequality and paving the way for a more active response from governments that hurts corporate profits and shareholder returns down the road.

Quick Hits — What’s on the markets radar?

Low interest rates are powering up the US housing market. With long-term fixed mortgage rates at a record low, the latest purchase application activity index has climbed to its highest level since 2009.

Oxford Economics notes:

“The steady rise in mortgage applications, which started in mid-April, points to improving home sales in upcoming reports. Despite the sharp downturn in the economy due to the coronavirus pandemic, some households clearly have the confidence to make a home purchase in the current environment.”

Falling measures of core inflation suggest economies face a deflationary hit from Covid-19. State Street beg to differ and highlight via this chart the importance of weights used in calculating the Consumer Price Index. These tend to contain heavier weightings to spending on segments such as transportation, airfares, eating out and lodging.

Alberto Cavallo, of Harvard Business School and an academic partner of State Street Associates argues in a current paper that a set of consumption weights using alternative data on credit and debit card spending shows “more than half of the fall in measured inflation rate seen since January is due to this ‘basket’ distortion”.

The upshot:

“The current risk of deflation looks to be more illusory than real and the ‘true’ rate of inflation is arguably higher than reported.”

Howler alert

Google and Facebook are part of the S&P 500 communication services sector and not the consumer discretionary group as I wrote on Tuesday. Apologies.

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