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There was another new page for the market history books on Tuesday after the yield on the two-year gilt fell towards the same level as the equivalent debt in Japan. There was also a hint that the pullback in US tech shares might just be the start of something bigger.

The consequences of Covid-19 for markets and investors have already been profound despite being less than six months into a lengthy journey of discovery.

One troubling outcome would be the prospect of more countries following Japan and the eurozone into a sustained world of negative rates. At this juncture of the pandemic, market debate leans more towards a slow recovery, dubbed a U or a W, rather than a V-shape rebound. Here’s what the latest monthly fund manager survey from Bank of America says about the recovery stakes: the V-shaped camp is losing ground.

Still, there is a degree of divergence between various countries. Some look at the renewing of lockdown measures in California and contrast that with a smoother pace of reopenings across Europe. That has the euro knocking back on the door of $1.14 (its highest close since a brief surge in early March) with many analysts singing a bullish tune about the single currency. A popular target of $1.20 was last seen in May 2018. The latest trade data from China also suggest a steady recovery, although there are signs that some “offshore” travellers are dropping off the bandwagon for equities.

A much weaker US dollar appears pivotal among many second-half outlooks. A big drop in the reserve currency would bolster emerging markets and cyclical equity sectors. But among the laggards, it’s not hard to see why UK equities sit at the bottom in terms of global fund manager weightings, as shown here:

For a UK economy imbued with a hefty reliance on the service sector, the pandemic has been very tough, so one can understand why the government is trying to reopen the country at a faster clip. On a personal note, I have lately been writing a few days a week from the Financial Times office near St Paul’s Cathedral. The City remains a ghost town with many shops shuttered and, apart from a few souls, so is the FT office. While I’m certainly grateful for the solitude after penning many lockdown notes from my bedroom, this is not a good indicator of a stronger economic bounce.

The latest UK gross domestic product data for May showing a rise of 1.8 per cent arrived well below a forecast jump of 5.5 per cent, and underscores the challenge facing policymakers.

Line chart of Indices, rebased showing UK output remained depressed in all sectors

Investec’s Philip Shaw believes:

“Data over the next few months should be more convincing than today’s disappointing figures. Indeed, we would still characterise the recovery trajectory as a ‘lopsided V’. Nonetheless the risks are clearly tilted towards a flatter rebound, especially towards the end of the year.”

For some time, the UK bond market, via negative short-dated gilt yields, has sent a blunt message that a protracted recovery beckons. In turn this has hobbled the pound beyond the wearisome post-Brexit trade negotiations with the EU.

Line chart of 2-year yields (%) showing UK government borrowing costs slip to match Japan levels

With two-year gilt yields sinking towards a low of minus 0.135 per cent, before bouncing a touch to minus 0.11 per cent, the pound slipped towards $1.2480 at one stage on Tuesday, less than 24 hours after tasting the air above $1.2650.

However, in terms of new market records set during the brief pandemic era, nothing quite matches the rebound in US tech shares. The Nasdaq 100 had rallied more than 50 per cent from its March low and was up more than one-fifth on the year earlier this week.

To a point, the sharp decline in government bond yields enhances the valuation case for owning companies with strong growth prospects. And this has only intensified what was an already crowded trade before the pandemic erupted. The latest BofA survey of fund managers recorded the highest ever response for US tech stocks constituting the most “crowded trade”.

Investors, particularly those of a retail persuasion, have in recent months certainly chased tech and other companies that appear to have limitless upside. But judging by some of the current commentary, leakage from the speculative bubble should not surprise anyone. Tech rebounded on Tuesday, but for the second straight day, the Nasdaq was lagging Wall Street, with cyclical stocks a winner.

Eleanor Creagh at Saxo Bank notes that the tech rally, reflecting an “acceleration of secular growth themes like working from home, digitisation, cloud computing and ecommerce”, means “these extended valuations leave little margin for error should the companies disappoint the lofty expectations”.

Momentum is a powerful driver of any market and in early trading on Tuesday, tech was in rebound mode.

Sébastien Galy at Nordea Asset Management views the recent price action in the Nasdaq as “a first warning shot for growth stocks” that “might take a few weeks for the trade to come undone”. The process likely involves the compression of Nasdaq volatility “as risk is priced out with common sense. The clock is ticking, significant prudence is warranted.”

Quick Hits — What’s on the markets radar?

The latest earnings results from US banks, led by JPMorgan and Citi, tell a story of trading revenues offsetting bigger loan loss provisions. But a lengthy cycle of loan losses and business failures remains a legitimate risk scenario (just look at the initial reaction to the results from Wells Fargo). And one that keeps long-dated yields in the basement and value investors waiting, like a certain Samuel Beckett play.

All eyes on the latest meeting of Opec and other producers on Wednesday, where the market expects a production increase of 2m barrels per day.

Helima Croft at RBC Capital Markets argues:

“The move is not without risk. Some of the more errant producers could use the easing as an excuse to revert to past practice and overall group compliance levels could erode.”

In turn, oil producers will have to act quickly should prices fall sharply, Helima says:

“Given the financial distress facing many Opec producers in a $40/bbl Brent environment, the margin for error appears rather slim.”

With US real yields negative all the way to a 30-year sitting at minus 0.21 per cent, the dollar looks rich, particularly when viewed against a number of emerging market currencies, led by South Africa, Turkey, Russia, Mexico and Brazil, according to BNY Mellon:

“According to our findings, fundamental valuation has had an almost exact inverse relationship to interest rates [and] are the most undervalued currencies across our entire estimation universe around the globe.”

With Brazil’s central bank in line to ease policy next month, BNY Mellon says the country remains a high yielder, “with inflation-linked bonds’ real yields ranging from 66bp for the 2023 issue, up to 3.9 per cent in the 2045 bond”.

As for Mexico, “real yields range between 1.3 per cent and 3.06 per cent in similar maturities”. 

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I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.

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