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SystematicEdge Monthly Market Overview June 2020

11 July 2020

MARKET CONTEXT: Equity markets and risky asset valuations further progressed in June despite the economic recession and fears of a second wave of Covid-19 infections. Going forward, we expect financial markets to be largely affected by how the spread of the virus is contained and the impact on economic activity.

Global Macro: We note significant disparities across countries regarding the evolution of infection rates. The situation has largely improved in continental Europe and some parts of Asia; however, daily infection rates have been rising again in a number of US states, while the situation is still not under control in India and most of Latin America. Coupled with the risk of a second wave of infections and the time necessary to develop a vaccine (12 months at best according to experts), the road to recovery and economic normalization will be long. The International Monetary Fund revised down its growth forecast for the global economy at -5%, versus +3% before the Covid-19 pandemic. In the US, officials expect GDP to contract 6.5% in 2020, before rebounding 5% in 2021. We note China's manufacturing activity beat expectations in June confirming that the recovery continues in China.

Financial Markets: The asset valuation’s floor provided by central banks and governments is more solid as it is maintained dynamically through ongoing intervention when needed. As such, we believe investors should remain invested. In the short term, markets remain vulnerable as governments gradually ease coronavirus lockdowns and travel restrictions to stimulate economic growth while attempting to control the spread of the virus. Overall, market sentiment remains positive amid the reopening of economies, while investors that have missed the rebound are buying at the highs. We expect the markets to react frenetically to any positive news regarding the development of a Covid-19 vaccine. Meanwhile, the economic sector rotation carries on, with tech stocks already up and cyclical sectors (in particular financials and industrials) further rebounding. Short covering of cyclical stocks and European stocks have continued to drive up equity prices.

Equity: Month to date the S&P 500 rose 0.9%, Hang Seng +6.4%, Euro Stoxx +6.0%. Fixed Income: 10-year US yield increased 1bp in June to 0.65%. Emerging market government bonds gained 3.1% in USD and 0.3% in local currencies. High-yield corporate bonds were up 2.0% in EUR and down 0.2% in USD. Currencies: USD slightly weakened in June: EUR +1.2%, CNY +1.0%, BRL -2.4%, AUD +3.6%; safe haven JPY +0.1%, CHF +1.6%. Commodities: Oil rebounded while gold maintained its uptrend: WTI Oil +12.7%, Gold +3.2%.

Risks:

  1. Covid-19: A second wave of infections could result in new lockdown measures, with a dramatic impact on economic activity, further delaying the global recovery.
  2. Wave of bankruptcies: As businesses struggle to stay afloat amid the economic recession, bankruptcies may increase in the coming months, further aggravating the economic situation.
  3. US-China tensions: On a geopolitical level, US-China frictions will continue to have an impact on the global economy. The adoption of China’s national security law for Hong Kong has increased tensions between China and Western countries.
  4. Tech bubble: The risk of a bubble on tech stocks remains strong, given high P/E valuations.
  5. US election: We expect the upcoming US presidential election to increase uncertainty in the financial markets, resulting in higher volatility.

Opportunities: We favour sectors whose valuations are underpinned by the stimulus of central banks and governments. We highlight banks’ low P/B ratio and high dividend potential (5%) from 2021. We believe Chinese equities have the potential for double-digit appreciation in the long run, led by secular growth sectors such as e-commerce, internet technology, healthcare, and education. Chinese equity valuations are the lowest of the main equity markets while dividends remain substantial (4.5%).

S&P 500 vs Profit Margins