By Jan Faure
US equity markets surged higher in July following strong financial results from major technology companies.
The S&P 500 Index gained 5.5% in July following robust financial results from tech heavyweights Apple (+18.4%), Amazon (+9.5%) and Facebook(+8.7%). In China, the blue-chip CSI300 Index rose 12.8% while in Europe stocks were more subdued with the Euro Stoxx 50 Index declining 1.8% for the month.
European leaders did temporarily lift regional sentiment when they finally agreed on a €750 billion rescue package. The package of grants and loans will be aimed at supporting the Eurozone's hardest hit countries. This came as the Euro zone registered a 12.1% decline in second quarter GDP which was worse than markets had expected.
European markets have lagged the recovery in the US equity market. Some of the under performance is due to the make-up of US markets, with the technology and healthcare sectors (this year’s star performers) making up over 40% of total market capitalisation. In Europe, these two sectors make up around 25%.
The US economy measured its worst ever annualised GDP contraction of 32.9% for the second quarter of 2020. That came despite the trillions of dollars spent in stimulus cheques, unemployment benefits and loans to businesses.
Previously US GDP had never shrunk by more than 10% on an annualised basis in any quarter. The US economy should bounce back in the third quarter,although a recent surge in coronavirus cases could hinder the extent of the Q3 recovery.
Gold was firmly in the headlines in July as it neared $2,000 per ounce for the first time ever. As at end-July gold is up 30% year-to-date.Contributing to the rally has been global instability caused by the Covid-19 crisis, as well as the dollar’s recent weakness and record low yields on government debt. Since gold is a zero-yielding investment, it tends to outperform when real interest rates are negative (currently the case in most of the developed world).
Many of the stimulus measures so far announced have been short-term in nature. When they run out there needs to be one of two things happening –either economic conditions need to have improved to a point where businesses can stand on their own two feet or additional top-up measures are required. What has been largely absent from rescue and relief measures is more permanent initiatives such as infrastructure projects and long-term tax cuts. These, by their nature, have longer lasting positive effects on an economy and may follow in due course. They also have a tendency to be more difficult to pass as they are more politically sensitive.
Going forward we expect both fiscal and monetary policy to remain highly accommodative and this should provide a supportive environment for stocks. Aggressive global stimulus measures have seemingly removed the risk premium from equity markets. The consensus view has been to ignore company earnings, which don’t support current valuations, and instead focus on the massive liquidity injected into the global financial system by central banks.There is however a high likelihood of elevated volatility going forward,especially with a US presidential election ahead, strained US-China relations and uncertain news flow around Covid-19 treatments and vaccines.
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