Market sentiment faces an important second half of the year after equity and credit valuations have rallied sharply during the current quarter.
Mark Dowding at BlueBay Asset Management argues that a moment of truth is approaching for markets and investors during the second half of the year:
“It is possible that by the end of July we should either be able to conclude that the worst is now behind us, or whether the real pain is yet to come.”
Indeed amid all the fanfare of a strong second quarter, over the past week, a sense of trepidation has loitered with the FTSE All-World index off about 2 per cent, with Wall Street falling sharply on Friday (the benchmark retains a gain of 17 per cent since the end of March). Such a retreat may simply reflect a squaring up of positions and rebalancing within portfolios between various asset classes ahead of the quarter ending next week. The strong performance of equities from March entails selling winners and raising allocations towards other assets, such as government and investment grade-rated bonds.
The recent pullback in equities and credit has been accompanied by falling yields on sovereign bonds. Notably the US 30-year Treasury bond yield dropped below 1.40 per cent today, back to a level seen in late May and down from a recent push above 1.60 per cent. Portfolio managers appear open to the idea of lightening up on risk and adding some ballast in the form of long-dated Treasury paper.
Near-term sentiment for emerging markets has also cooled, while another strong performer gold has faded from a test of $1,800 an ounce this week, in part reflecting the recent bounce in the US dollar.
Typical quarter-end dynamics, you say. Or perhaps, there is a little more going on below the waves.
Clearly the enhanced presence of central banks explains much of the rebound in asset prices from their lows in March. The problem is that gushing amounts of liquidity mask the underlying challenge facing the broader economy. No matter plenty of cautionary tidings from central bankers of a long and protracted recovery process — a point reinforced by the latest IMF outlook this week — market valuations have rebounded impressively. This leaves asset prices fully loaded for a second-half recovery story in global economies, corporate earnings and, of course, a pandemic firmly on the retreat.
Dario Perkins at TS Lombard warns that asset prices face a test as the power of “monetary policy is becoming less effective at stimulating the macro economy” and “financial markets cannot diverge from macro fundamentals indefinitely.”
Now there is scope for a bounce in economic activity during the third quarter, but that will only mitigate some of the damage inflicted by shutdowns in the form of elevated unemployment, weaker earnings and plenty of caution from businesses and consumers over their spending plans.
Mark at BlueBay highlights a couple of important points for investors in the wake of the recovery across risky asset classes during the current quarter:
“We would continue to draw a distinction between those assets which central banks will purchase, versus those they will not, and in many regards it seems this distinction has gone largely forgotten in the rally during the past quarter.
“We would also observe that while this Covid recession may be very different to past recessions, we are witnessing a material contraction in output nonetheless and don’t expect to have recovered fully before late into 2022.”
Three months from now, a clearer picture should be apparent, and such a wait may well spur a lot more choppier price action across markets.
Didier Saint Georges at Carmignac argues that investors are operating in a climate that lacks visibility. Global cases of the virus are still rising, while the reopening of economies and the risk of renewed cases may well keep consumers and businesses in bunker mode. In this regard, Didier notes that for China, “trends in such consumer-related services as hotel occupancy and subway passenger traffic are regular but quite slow, and not converging really towards the pre-crisis level”.
He says the lack of visibility entails an investment approach that in terms of equities sticks with “high quality growth companies that have shown the resilience of their business models, and gold producers to address the global macro risk”.
Another talking point at the moment is that of various fiscal support measures ending in July, raising the prospect of renewed downward pressure on the economy. In the US many think another round of fiscal stimulus beckons, so that August does not become even hotter for those without jobs or facing the ruin of their businesses.
Some analysts think a lot more fiscal support is required and TS Lombard’s Dario Perkins notes:
“The important question is whether officials have done enough to return the global economy to its pre-pandemic trajectory. We think they haven’t and that ultimately a large, multiyear fiscal expansion will be necessary, not just zero yields and endless rounds of [quantitative easing].”
That suggests an extended scale looms for this chart before the end of the year:
Quick Hits — What’s on the markets radar?
Research Affiliates takes aim at the tendency among investors and pundits to label asset classes as being “irretrievably broken after poor recent performance”. The California-based firm argues that such “hype” is misplaced and looks back at various examples. These include the death of equities in 1979, the demise of real estate investment trusts in the late 1990s, along with permanently cheap oil in 1999 and then small-caps in 2000. More recently, there were question marks over high yield in 2008, to 2019’s death of value investing and owning emerging markets.
“In the five years after an asset class was declared broken, each roared back in a strong, and for many, swift rebound. All except one — Reits took 18 months to rebound — snapped back within one year, generating returns that ranged from 14% for US stocks to 68% for commodities.”
The firm reminds us:
“Far too many investors focus on the rear-view mirror and react to fear-inducing headlines. Doing so incurs the risk that investors will miss good opportunities.”
Finally, after a three-month delay Liverpool are now worthy Premier League champions. And yes, like a patient value investor, I have waited a long time for this moment.
A good weekend to all readers and thanks as always for your feedback.
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