The rise in equities was confirmed in May
The uptrend in equities that began in April was confirmed in May, despite some profit taking and a hesitant start to the month. Global equities rose by 4.2% in May to their highest level since 6 March (MSCI AC World index in US dollars). They have rebounded by 33% from the lows of 23 March, meaning they have now only fallen by 9.9% since the start of the year. Indeed, some indices (Nasdaq composite) and sectors (technology, healthcare) are now higher than at the end of 2019.
The main catalyst for the gains was the expectation of a rapid economic recovery as, in many countries, the slowdown in the pandemic allowed the gradual lifting of containment measures.
The return to - a new - normality will likely be gradual as restrictions are set to remain in force in several sectors (particularly leisure and hospitality).
Even so, the lack of signs of fresh COVID-19 outbreaks has reassured investors, who are also closely watching for any progress in medical research. As an example, just into the second half of the month, the encouraging news about the development of a vaccine led to a sharp rebound in equities despite the less positive information subsequently put out by the US biotech company involved.
Despite all this, the company earnings forecasts from financial analysts suggest a favourable assumption for end-of-year growth after a tough second quarter.
Pandemic’s economic effects make themselves felt
Unsurprisingly, economic indicators have worsened horribly: Hard data for April (industrial production, consumption, employment) clearly reflected a full month of containment almost everywhere in the world except China, where activity actually showed signs of reacceleration.
In the US, for example, household expenditure fell by 13.6% (on top of a 7.6% drop in March), while in France, household spending on goods fell by 20.2% in April.
Business surveys picked up modestly in May as the outlook sub-index improved. The latest indices are still far from reflecting a normal situation or even a significant economic rebound after the collapse seen in March and April. Q2 GDP can be expected to shrink by significantly more than it did in the first quarter.
Economic policy support reinforced
The performance of risky assets shows that investors have welcomed central banks indicating that monetary policies would remain highly accommodative, and government announcements of new fiscal stimulus plans.
The European authorities' proposals seem to have convinced market observers. While there is still a long way to go and discussions are likely to be highly animated, the affirmation of European solidarity (especially by France and Germany) is an important step.
The French-German initiative on Europe’s recovery from the coronavirus crisis was welcomed by the market. The project will allow the European Commission to finance a recovery by borrowing on the markets on behalf of the EU. The EUR 500 billion fund will support the most affected sectors and regions on the basis of the EU’s budget programmes.
On 27 May, the European Commission presented Parliament with its Recovery Fund, amounting to EUR 750 billion (i.e. more than that of the Franco-German initiative of 18 May). The fund comes in addition to the multiannual European budget of EUR 1.1 trillion and will be split between grants (EUR 500 billion) and loans (EUR 250 billion) to the member states.
The approach is a little different from that suggested by Chancellor Merkel and President Macron as it is about helping the poorest countries first (in terms of GDP per capita) and the details remain to be fully defined.
Negotiations will continue even though some northern European countries (the “Frugal Four”) have expressed their opposition to subsidies. Despite such uncertainties, 'peripheral' markets rose on these announcements: the Italian 10-year BTP yield eased by 28bp over the month to end at 1.49%, its lowest since the end of March. The Spanish 10-year rate fell back to 0.50%, i.e. a monthly easing of 24bp.
A dangerous geopolitical situation
The month was marked by renewed tensions between China and the US over the national security law that Beijing wants to impose on Hong Kong, while previous weeks had been punctuated by US statements denouncing the Chinese authorities' role in spreading coronavirus. The Chinese authorities referred to a ‘new cold war.’
Against this background, the MSCI Emerging Markets index, hit by the drop in its Asian component, underperformed (+0.6% in May) despite the rally in Latin American equities.
Within the major developed market indices, the biggest positive return came from Japan, where the Nikkei 225 Index rose by 8.3%, led by cyclical and export related stocks. In the US, the S&P 500 posted a rise of 4.5%, while the Nasdaq gained 6.8% in May and was up by 5.8% compared to the end of 2019. In the eurozone, the EuroStoxx 50 gained 4.2% in May but remains behind by 18.6% so far this year.
Positive over the medium term; monitoring needed in the short term
Our baseline scenario is of a deep recession in the H1 2020 followed by a gradual but bumpy recovery. We believe that the highly proactive economic policies implemented to kick-start consumption and support companies point to a favourable trend for risky assets in the medium term.
In the short term, after a 15% rise in global equities in two months, things may become bumpier, in line with any news on economic indicators and health.
Indeed, investors will have to weigh up whether the damage to economies is temporary or permanent, especially in terms of employment. They also need to assure themselves that the easing out of lockdown does not provoke a new COVID-19 outbreak.
While the resilience of economies and the success of exit strategies remain critical, it has been the hopes of a rapid economic recovery that has explained most of the rise in risky assets in recent weeks.
Disappointments in business surveys, after the modest rebound in PMI indices in May, could thus lead to a fall in equities. The difficulties in realising some of the fiscal measures announced in May could have the same effect.
However, we believe that equity index corrections may be opportunities to reposition.
Geopolitical and trade tensions between the US and China, back in the spotlight in May, are an additional risk for markets, where the normalisation of stress indicators remains fragile and, in essence, linked to central bank action.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.