Weekly Investment Insights

 

A helping hand

Written as at 10th of July 2020

“We have the Fed [and the ECB] to juice bull markets, China has its state media” is a timely quote to explain activity on equity markets as of late.

A front-page editorial in the state-owned China Securities Journal was credited for fueling a strong rally in Chinese markets that spread to global equities at the start of the week. The publication noted prospects for a “healthy bull market” and said investors should look forward to the “wealth effect of the capital markets”. Furthermore, and according to different analysts, it was alleged that this rally wasn’t driven only by rhetoric, with “state-backed” buyers reportedly intervening in markets.

There could be a long list of reasons behind the “accredited” support for Chinese equity sentiment. An obvious economic boost from the wealth effect, at a time of tepid external demand, is the most obvious one. Another reason could be to support a stable exchange rate via capital flows, in order to avoid further fanning tensions with the US Administration.

History is full of examples of policy makers using the media to drive up the market. But souvenirs of 2014/2015 are still biting. At that time it ended up badly with a significant market crash. If you believe that this time is different (we believe that change is the only constant, as said by Heraclitus), it’s worth understanding the ways in which the current, frenzied move is different: valuations began from a lower starting point and there was a significantly lower (but increasing) level of leverage exposure. While the current rally looks hot, catch-up potential is also significant vis-a-vis the US equity market while looking at the bigger picture over a longer time horizon. For now, some sort of short squeeze seems to be at play.

Moving to politics, President Trump hosted the Mexican President “AMLO”, at the White House to spotlight the new North American trade deal between the two sides as well as Canada. Trade looks set to be a hot topic in the coming months with President Trump potentially pushing a stronger “America First” policy in the run up the November elections. No such progress was seen with regard to Brexit negotiations with British Prime Minister Boris Johnson allegedly telling Angela Merkel that the UK was prepared to leave on “Australian terms” (i.e. with “no deal”). In Europe, Ireland’s finance minister Paschal Donohoe has been elected as the new president of the Eurogroup, succeeding  Mário Centeno. Donohoe said that he was confident that the Eurogroup could play an “essential role in forging a consensus” on policy decisions for the entire bloc.  

On the subject of consensus, this week, focus will fall on a meeting between EU leaders in Brussels (July 17-18th) to try to reach a deal on the bloc’s long-term budget and coronavirus recovery package, as well as some key central bank meetings.

Key focus for next week:

MondayChina Outstanding Loan Growth and M2 Money Supply (June)
TuesdayChina Balance of Trade (June)
Japan industrial Production (Final, May)
US, Germany and Spain Inflation data (June)
Eurozone ZEW Economic Sentiment Index (July) and Industrial Production (May)
UK Balance of Trade, Industrial Production and GDP Growth (May)
WednesdayJapan Bank of Japan Monetary Policy Meeting and Quarterly Outlook, Reuters Tankan Index (July)
UK and Italy Inflation data (June)
US Industrial Production (June), Fed Beige Book
EU-India Summit
ThursdayChina GDP Growth (Q2), Industrial Production, Retail Sales, Unemployment Rate (all June), NBS Press Conference
ECB Monetary Policy Meeting
Eurozone Balance of Trade (May)
US Retail Sales (June), Weekly Initial Jobless Claims, NAHB Housing Market Index (July)
FridayUK Gfk Consumer Confidence (Flash, July)
Eurozone Inflation Rate (Final, June)
US Michigan Consumer Sentiment (Preliminary, July)
EU Meeting on Common Recovery Plan Begins

Latest publications:

The Way We Live Now: The way we live has been altered: The pandemic has ushered in the digital revolution quicker than we could have anticipated and its key facets – home office, telemedicine, eLearning, … – will stick. This has various implications for investors which we discuss in our latest myLife piece.

Macro

US

This week was light for macro news, with no hard data in the US. We just had the ISM non-manufacturing survey for June, which easily beat expectations, rising from 45.4 to 57.01 (vs a modest 50.2 expected). Stripping out the supplier deliveries component which blurs the understanding of the index during a supply shock, the index rebounded even stronger than it appeared to. The number of industries reporting growth increased dramatically from May (from 4 to 16), with the largest industries reporting growth being Accommodation and food services, wholesale trade and real estate. Respondents acknowledged the improvement in activity, but remained cautious on the outlook due to the risk of a resurgence of the disease (or the uncontrolled spreading of the new infection clusters). In terms of sub-components of the index, New orders and Business activity components increased strongly (respectively from 41.9 to 61.6 and from 41.0 to 66); with the progressive removal of lockdowns, supply-chain gluts eased. The negative spot remains employment, which is still reported to be in deterioration though at a milder rate (index level at 43.1 – below 50 – vs 31.8 prior).

EUROPE

In Europe, we had Factory orders in Germany, rising less than forecast in May, despite the beginning of removal of the lockdowns. Orders rebounded by 10.4% (15.4% expected) after April was revised down from -25.8% to -26.2%. The main disappointment came from the consumer goods sector which rebounded only slightly. This disappointment echoes similar weakness in the US industrial sector, and highlights the uncertainties around the recovery scenario. There were great divergences in terms of geographic origin of orders. Orders from within the Eurozone rebounded by 20.9%, whereas non-Eurozone orders were up by just 2%. Domestic orders (from within Germany) rose 12.3%. And finally, Industrial production in France was published for the month of May, largely beating the consensus, which is at odds with what we have seen in other large countries. Production rebounded 19.6% from a 20.6% fall in April, when the market was expecting a 15.4% rebound. ; within industrial production, manufacturing rose 22%, almost in line with an ambitious consensus (22.8%). While the rebound is sizeable and a welcome surprise, production remains 24.3% below the same level last year, which is no surprise in the current environment.

CHINA

In China, June’s headline CPI rose modestly from a year ago by 2.5%, driven mainly by food prices (which rose 11.1% YoY in June, reflecting near-term slowing in supply and improving demand conditions), while core CPI eased modestly to 0.9% YoY. PPI deflation eased somewhat, falling 3% YoY  (or up 0.7% month-on-month), on the back of the recovery in global oil prices and a moderate rise in ferrous metal prices. The outlook for easing CPI inflation going into Q4, leaves room for further monetary easing in the second half, led by credit expansion and further cuts to the reserve ratio.

To counter the possible deterioration in loan book quality for regional banks as a result of Covid induced challenges, the State Council said it would allow local governments to use “special-purpose bonds” to help regional banks increase capital buffers. In addition, regional banks can raise capital via equity and bond financing. The news boosted market sentiment and sent the banking sector higher.  

The PBOC, the Hong Kong Monetary Authority and the Monetary Authority of Macau jointly announced the implementation of a cross-border pilot scheme called “Wealth Management Connect” in the Great Bay Area. This marks another important milestone for the Mainland’s capital account liberalization and represents a breakthrough in HK’s offshore RMB business development and a significant step in fostering closer financial cooperation between the three.

Equities

The challenge facing equity investors is how to invest in an environment where asset prices appear disconnected from the real economy, while the resolution of the health crisis remains in the distant future.

The past few months have been unprecedented in many ways: the scale of the healthcare crisis, the extent of the economic and financial market disruptions and the unparalleled policy response – its size, coordination and new initiatives.

Early June, value stocks (banks, industrials…) which look cheap compared to their fundamentals started beating growth companies (chosen for superior growth profile), after a losing trend that had lasted more than a decade. The rally lasted a paltry ten-days. Since then, value stocks have taken a leg back down again, while the growth stocks index of large U.S. companies hit a new all-time high. Value stocks and more specifically banks and some industrials sectors like automotives, which are very fragile and risky, remain generally ill-oriented in the long term. They are the most exposed to negative events, whether they are linked to the coronavirus, the macroeconomic situation or even US-China tensions.

It may be too early to draw conclusions on the long term implications for equity investors, however, it is already possible to identify new trends and existing trends that have been accelerating and gaining traction. Sectors such as travel, leisure, airlines, office real estate, hotels, restaurants… are facing new major headwinds with the growing shift to working from home and with travel limitations still in place.

For other sectors, the pandemic has reinforced headwinds that were already in play: the shift to online retail, the decline in oil consumption and the technology transition facing the automotive industry. Changes in consumer behaviour reinforce positive tailwinds for some online retailers, content providers, logistics real estate, payments software and IT in general. Increasing health awareness should benefit  pharmaceuticals and healthcare equipment.

Companies who successfully digitalized their business models should benefit. Disrupters across industries have the potential to deliver high earnings growth in a low-growth world.

Fixed Income

Last week, performance in the bond markets was driven by risk sentiment and large auctions as the economic calendar was very thin.

Financial markets started the week on a positive note as the impressive rally in Chinese assets helped markets to adopt risk-on mood, but the momentum faded later in the week on Covid-19 concerns.

 As a result, the yields in core government bond markets bull flattened. The German 10-year bund yield dropped by 5 basis points (bp), while the 2-year bund yield hardly changed. In the US Treasury market, we noticed a similar move with the 10-year treasury yield dropping  almost 10 bp and the 2-year just falling by 1bp. Peripheral spreads over Germany widened by 5 bp on average over the week.

On the corporate bond indices, the credit spreads for European investment grade remained flat, while US investment grade credit spreads widened by 3 bp.  For High Yield corporates, credit spreads widened on both sides on the Atlantic. The liquidity in corporate bond markets has improved over recent weeks and investors are returning to this sub-asset class.

The main highlight on the bond markets during the week was a string of record large auctions. A US 3-year treasury auction (record $46 bn) met decent investor interest. The Auction ended at a record low yield of 0.19% with an average bid cover of 2.44. In addition, the US Treasury department did a reopening auction for $19 bn worth of 30-year bonds. The strong demand stopped the yield at 1.33%. Moreover the day after, the US treasury tapped the market again with $29 bn worth of 10-y notes with a record low yield of 0.65%. These large bond sales  extended the flattening move on the US curve.  The high demand on the 30year auction and the flattening of the curve indicates that the investors expect yields to stay low for several years. This is not a very optimistic sign!

Moving to this week,  central bankers will take the centre stage.  On Wednesday, the Bank of Japan will make its monetary policy decision but no change is expected. On Thursday, we will have the ECB and we expect the policy statement to be unchanged as well. At the previous meeting the ECB decided to expand the envelope for their Pandemic Emergency Purchase Programme by a further €600bn, bringing the total up to €1.35tn.