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Moving on too soon?

Sunset on a road

For financial professionals only

Life goes on…and in markets that appears to have happened with dramatic speed. Despite the world falling into a self-imposed and coordinated recession, risk assets have returned in most part to pre-Covid levels – and in some cases, have shot past this.

In bond markets, credit spreads have bounced back despite a weaker economic outlook, coupled with drastically higher debt levels. In equity markets, the S&P 500 has reached new heights.

Questions of whether this is justified and identifying the inherent risks are difficult to answer at the best of times, but in the wake of a pandemic require a new level of granularity.

The devil’s in the detail

It’s easy to say that market rebounds have been driven by the wall of monetary spending (and this time Fiscal) and to some degree, this is true. But the devil is in the detail, and the S&P 500 performance shows why investors need to be cognisant of the headline index performance, and the businesses that collectively make this up.

Many large companies within the S&P have benefited from the lockdown. Indeed, the FAANGM (FAANG’s plus Microsoft) have added over 9% to the YTD figure for the S&P. Meanwhile though, the remaining companies have added nothing. Traditional companies have suffered – and suffered badly. We are seeing huge variation in sector performance, with Energy and Financials the biggest losers.

In addition, not every equity market has seen the headline recovery enjoyed in the US. The FTSE All Share still languishes way below its level in February. A quick look at the sector breakdown, a poor record in responding to Covid and renewed Brexit uncertainty explains this.

Away from market moves the economic data remains uninspiring, with European Manufacturing Purchasing Managers Index (PMI) mirroring the US last week, highlighting a diluted recovery rate post the bounce of the first month or two. Germany had a services PMI of 50.8, barely moving in the last month, despite 4 previous months of dramatic contraction. From a low base, production is still finding it hard to expand.

Where do we go from here?

What we can now state with certainty is that Covid-19 is not going to be extinguished with a 1 to 2-month lockdown, not least because we’re 4 months past that point. For the foreseeable future there will be a multitude of temporary restrictions across the world, as governments react to recurring spikes in infection rates.

As spikes become more localised, and we see likely improvements in treatment and reduced mortality, the social and economic impact of the spikes in infection may lessen as the world becomes more sanguine with this environment.

Investors must ask themselves if the recovery to growth implied by markets is in line with their expectations of the Covid drag, and if the spending necessary to support it is in line with their understanding of the future support from governments and central banks.

On that last point, it’s worth considering if another round of massive stimulus will lead to near-term or long-term interest rate rises. Inflation may be something of a distant memory, but the mechanism for money to flow from central banks through retail banks and into the economy is in a much better place now than it was after the Financial Crisis in ’08. We now have the advantage of stronger bank capitalisation and, thanks to Covid and trade wars, a reduction in globalisation.



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