The World Health Organization is beginning to see ‘worrying trends’ in the number of COVID cases, intensive care admissions and hospitalisations in the northern hemisphere as it enters the colder season. Data for France, Spain and the UK show that even though most new cases continue to be among the young, the virus is now spreading across all age groups. As public health experts predicted, school re-openings and more indoor activities are factors behind the recent trend reversal. Halting a second wave could involve difficult trade-offs. Curbing the virus without new national lockdowns means limiting social mixing, but any additional public health measures will likely weigh further on economic activity. There is a risk that the market falls into the trap of dismissing local measures until they all add up and tilt the economic outlook.
The number of new COVID-19 cases continues to rise at an alarming pace in the UK and in Europe. The risk of renewed lockdowns is increasing by the day and hence the need for further fiscal support. So far, fiscal support has been waning. This backdrop is driving a slowdown in economic activity. As such, risks of a slowing in economic growth in the fourth quarter are rising. The key risk is that the infection rates increase substantially as we go into the winter months.
Today, the eurozone purchasing manager index (PMI) for September was published. This is the market’s primary source of timely information on month-to-month changes in economic activity in the single currency area.
The composite PMI fell by almost two points to 50.1, effectively a rounding error above the 50 ‘no change’ level (PMI prints below 50 imply economic contraction). For the last two months (July and August), the composite had been clearly above 50. This followed three months of major declines (March, April and May) and one month (June) of modest contraction.
Today’s data suggests to us that the economic recovery in the eurozone has stalled. The PMI survey continues to flag disinflationary pressures in the economy, with companies increasingly reporting the need to offer discounts to stimulate sales.
Risks around the path of activity through the last four months of the year in the eurozone (and hence quarter-on-quarter GDP growth in the fourth quarter) are therefore rising.
With the death, on 19 September, of Justice Ruth Bader Ginsburg (RBG), another vacancy – the third of this presidential term – has opened up on the Supreme Court of the United States (SCOTUS). President Trump has said he will announce his nominee to replace RBG later this week and Mitch McConnell, Senate majority leader, has committed to holding a Senate confirmation vote.
The only real question is whether that vote will be held in October, ahead of the election, or is delayed until the ‘lame-duck’ session between the election and beginning of the new Congress in early 2021. There seems, however, little doubt that by the end of the year, another conservative will have joined the court, creating a 6-3 conservative majority, and that the whole process will be rancorous.
The most immediate consequence for markets of all this is that it further reduces the probability of additional pre-election US fiscal stimulus.
As we have previously highlighted, since key stimulus provisions expired at the end of July, there has been little progress in bipartisan talks to pass another bill. With time running out before Congress breaks up for the election and against the backdrop of what could well be a bitter fight over a SCOTUS nominee, the prospect of harmony breaking out any time soon between Democrats and Republicans over more government support for the economy and jobs looks pretty dim.
Without further help, household incomes could well come under further pressure through the autumn and into the winter, denting prospects for consumer spending and wider economic growth.
This is a potentially critical topic because of the apparent consensus that the Federal Reserve’s newly announced framework for monetary policy cannot succeed without fiscal support from the US government.
A number of senior Fed officials have insisted on this point. Governor Lael Brainard, for example, has stressed that “the magnitude and timing of further fiscal support is a key factor for the (economic) outlook”. Yesterday, speaking to the House financial services committee, Chair Jay Powell warned that the economic recovery would suffer if lawmakers failed to pass a new stimulus package.
Accommodative central bank policy continues to be the key underpinning factor for global markets. It is likely that dovish central bank policy will not only keep interest rates locked down at the current low levels, but will also skew down interest rate volatility. In this environment, global bond yields are unlikely to move much. For this reason, there may be greater currency adjustments and a considerable likelihood of increased currency volatility.
The market is steadily pricing in a US election extension risk with November VIX futures contracts continuing to rise relative to October contracts. Moreover, election risk is also being priced into two months and longer options in the key US dollar foreign exchange pairs.
The offshore Chinese yuan (CNH) continues to strengthen versus the US dollar, spurred by the improving economic recovery in China compared to the rest of the world and by inflows into Chinese assets. Currently, the US-China trade concerns are not playing much of a role in the direction of the US dollar against the yuan. However, US election risk is driving up the volatility premium.
In spite of the current market weakness, risky assets should remain underpinned by low 10-year US real yields and supportive financial conditions. The equity risk premium continues to make equities look attractive relative to bonds. So, while there may be volatility going into the US election and potentially somewhat beyond, corrections may provide buying opportunities.
Finally, large-cap tech stocks have recovered from their correction earlier this month. However, it is notable that since May, second-twelve-month forward earnings estimates have risen by less than they have for the rest of the market. The significant gains in tech price shares since March assumedly reflect a big rise in future earnings, but analysts do not seem to share that view.
The lack of more positive earnings estimate revisions explains why multiples for the sector have risen so sharply this year and remain high even after this month’s correction (see Exhibit 1).
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. This document does not constitute investment advice.
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.