Q3 2020 Quarterly Market Commentary
Global share markets higher
Global share markets were higher in the September quarter, rising largely on the back of expectations ongoing government and central bank policy support will continue to drive the global recovery. In Europe, we saw the European Commission agree to a EUR750 billion spending package aimed at helping those member nations most affected by the pandemic, while the US Federal Reserve (Fed) announced a material shift in its inflation policy in a bid to support both the labour market and the wider economy. The Fed said it will adopt a flexible inflation target, which aims to achieve an average of 2.0% inflation over time. This differs from the Bank’s previous policy, which was to maintain a 2.0% hard inflation target; 2.0% being the level the Bank considers optimal for maintaining a healthy economy. Under its new policy, the Fed will allow inflation to run moderately above 2.0% for some time following periods of low inflation, i.e. below 2.0%, before it raises interest rates. This new approach equates to a more dovish policy stance and implies that the Fed’s benchmark interest rate, which is already near zero, could potentially remain at its current level for several years even as inflation rises. Stocks also benefited from some promising developments on the coronavirus vaccine front – though an effective vaccine is still yet to materialise – and a series of encouraging US earnings results, with the likes of Disney, Apple and IBM all posting results which beat analysts’ expectations. US earnings generally surprised on the upside, though it’s worth noting that the bar for company earnings had been set relatively low due to the anticipated impact of the coronavirus pandemic. Sentiment was further buoyed by a sharp jump in US consumer confidence, improving euro-zone manufacturing activity and evidence the post-coronavirus recovery in China is gathering momentum, with the world’s second-biggest economy expanding 3.2% in the 12 months to 30 June. We also saw Chinese factory output expand at its fastest pace in almost a decade in August.
Limiting the advance was a late surge in new coronavirus infections globally, with the UK and several European countries, including Spain and France, forced to reintroduce stiff lockdown measures that could potentially undermine the global recovery. At the same time, we saw the number of confirmed cases in the US top 7.2 million while the death toll in the country surpassed the 200,000 mark. Perhaps more worrying, though, is that in the absence of a readily available vaccine, the number of new virus cases globally is likely to worsen ahead of the Northern winter. Stocks were also impacted by US government officials’ failure to agree a new stimulus package and some cautionary comments from Fed chairman, Jerome Powell, who said the US economic outlook remains highly uncertain and that greater fiscal stimulus is needed to support the recovery. Sentiment was further impacted by an escalation in US-China tensions and a late sell off in US technology stocks. Contributing to the rising tensions between Washington and Beijing was the former’s move to suspend its extradition treaty with Hong Kong and place restrictions on China’s largest chipmaker, Semiconductor Manufacturing International Corp. Importantly, though, the two sides did at least reaffirm their commitment to the phase one trade agreement they signed earlier this year. Meanwhile, the US technology sector sold off in September, with the likes of Facebook, Apple and Microsoft – stocks which have helped propel Wall Street sharply higher since late March – all posting material declines for the month. Other factors to weigh on sentiment over the period were sharp contractions in growth across the major economies, including the US, euro-zone and Japan, and renewed Brexit fears after trade talks between Britain and the European Commission stalled.
At the country level, US stocks performed well, with the benchmark S&P 500 Index climbing a further 8.5%1 for the quarter. Share markets were also higher in China and Japan but fell in the UK and Europe.
Markets are in the early recovery phase of the business cycle following the recession caused by the coronavirus outbreak. This implies an extended period of low-inflation, low-interest-rate growth, which is an environment that usually favours equities over bonds. However, after such a rapid rebound, an equity market pullback would not be surprising. Technology stock valuations remain elevated, while the US election is creating uncertainty around tax changes, government regulation and the US-China trade relationship. Beyond this, we believe the market looks set for a rotation away from technology/growth leadership toward cyclical/value stocks. This also implies a rotation toward non-US stocks which, in our opinion, would likely benefit Europe and emerging markets the most.
We maintain our preference for non-US stocks over US stocks. The second stage of the post-coronavirus recovery should favour undervalued cyclical value names over expensive technology and growth stocks. Additionally, we believe emerging markets should benefit from China’s early exit from lockdown and further stimulus measures.
For fixed income assets, we continue to see government bonds as universally expensive. Low inflation and dovish central banks should limit rises in bond yields during the recovery phase. In terms of credit, we have a neutral view on high-yield and investment-grade debt. Since their levels in mid-March, credit spreads have compressed and, in our view, only now adequately compensate for the likely rise in default rates following the recession.
In the currency space, we expect the US dollar to weaken into the global economic recovery due to its counter-cyclical behaviour, which has historically seen it decline in the recovery phase. Economically sensitive ‘commodity currencies’ like the Australian, New Zealand and Canadian dollars should be the main beneficiaries of this.
Moving forward, the major risks to our outlook include a second wave of virus infections and the US elections in November. Virus infection rates are picking up and the onset of winter in the northern hemisphere could trigger a more significant second wave. However, death rates have remained low in most countries and vaccine developments have been encouraging. The US election result may be contested, with destabilising implications for financial markets. We believe the re-election of President Donald Trump would likely benefit US stocks (tax hikes averted, more protectionism) whilst a victory for Joe Biden may benefit non-US stocks (more harmonious foreign and trade relations).