News & Insights
MARKET CONTEXT: Financial markets' complacency underpinned by the central banks and governments stimulus
Financial markets continued to be complacent in August despite weak fundamentals, largely driven by central banks’ and governments’ stimulus measures. The Covid-19 pandemic continues to weigh heavily on the global economy. Although the number of daily new cases in the US started to decline, a number of countries, including France and Spain, are now facing a second wave following the gradual relaxation of lockdown measures. However, better testing and face mask wearing requirements make it unlikely for national lockdowns to be implemented again.
Global Macro: Despite limited improvement in the Covid-19 pandemic situation globally, US equity indices rallied in August, reaching new all-time highs driven by the Tech sector. Meanwhile, there is no clear sign of trade war truce between the US and China, which expanded to the Tech sector, provoking disruptions among Tech firms around the globe. The real economy recovery is slowing, thus aggravating the disconnect between economic fundamentals and US equity valuations. We note clear market complacency from investors who refuse to see the reality of the upcoming wave of bankruptcies and the risks threatening earnings in the Tech sector. The market is mostly focusing on central banks’ continued accommodative monetary policy and governments’ stimulus measures. China’s economy further improved in August amid a strong industrial sector, increased business confidence, and rising home and car sales.
Financial Markets: The positive momentum of risky assets carried on in August, driven by the Tech sector. US equity indices are in overbought territory and equity options’ implied volatility is rising, pointing to investors’ anticipations of market turbulence for the rest of the year and during the US election in November. The “disruptive” Tech sector is being “disrupted” by trade tensions and the challenging of tech giants’ light taxation in a number of countries. The US dollar weakened, while gold will benefit from the Federal Reserve’s decision to shift to an average inflation target of 2% (as opposed to making 2% a fixed goal), in addition to the US negative real interest rate and continuous increase in US debt.
Equity: Month to date the S&P 500 rallied 7.0%, Euro Stoxx 50 +3.1%, Hang Seng +2.4%. Fixed Income: 10-year US yield increased 16bps in August to 0.69%. Emerging market government bonds gained 0.6% in USD and lost 0.7% in local currencies. High-yield corporate bonds were up 1.8% in EUR and 0.8% in USD. Currencies: USD further weakened in August: EUR +1.5%, CNY +1.8%, AUD +3.4%; safe haven JPY +0.0%, CHF +1.1%. Commodities: Oil price further rose while gold price contracted: WTI Oil +6.1%, Gold -1.0%.
Opportunity: The Tech rally of August, combined with the US-led trade war, further increased the valuation gap between expensive overbought markets (US, Tech) and cheaper markets (Europe, China, cyclical sectors). We anticipate that a rotation will take place by year end, when investors demand higher premiums for the risk they take as the economy slowly recovers within a volatile geopolitical environment. We believe China, Europe, and cheaper sectors, such as cyclical ones and financials, have double-digit growth potential.