By Jan Faure
Equity markets continued their recovery with most major indices making healthy gains in May.
The S&P 500 Index gained 4.5% (-5.8% YTD) in May while in Europe, the Euro Stoxx 50 advanced 4.2% (-18.6% YTD). In Asia, Japan’s Nikkei jumped 8.3% thereby narrowing the year-to-date decline to -7.5%. World emerging markets crept 0.6% higher, with year-to-date losses at -16.5%.
S&P 500 Index Year-to-date
The overriding driver pushing global markets higher in May was the gradual reopening of economies that were stalled by coronavirus lockdowns. The positive move in markets came despite an abundance of negative news, confounding many market participants. Economic data has been abysmal due to COVID-19 effects, US-China relations have deteriorated sharply, violent protests have broken out in the US, and the US government suspended funding to the World Health Organisation. Yet markets continued to push higher.
Markets are taking the view that a COVID-19 vaccine is on the horizon. So far over 120 vaccines have been proposed and there are approximately 10 in clinical trials. There is unprecedented funding available which has encouraged virtually all major pharmaceutical companies to pursue treatments and/or vaccines to combat the novel coronavirus.
US-China relations have taken a turn for the worse yet the crucial January trade deal has so far remained intact. With presidential elections only months away, President Trump is all too aware that a US economy in recovery mode and a strong stock market will boost his re-election chances. With the unemployment rate in the US expected to reach at least 20%, Trump will need all the help he can get.
Economic relief measures have so far been effective in stemming the economic fallout. The US has to date responded with pandemic relief spending of $2.4 trillion, which is expected to rise by a further $1 trillion in the coming months. The EU has proposed a 750 billion Euro recovery package while Japan has committed approximately $2.2 trillion to protect its economy from the effects of the coronavirus pandemic
Asset allocation is a key decision that investors must make. This decision defines what slice of the investment pie the primary asset classes of equities and fixed income should receive. The challenge facing investors in these risk-off times is fixed income, the traditionally safe haven asset class, is at historically low yields. Virtually all high-grade bonds are yielding close to zero, or below zero, offering investors very poor returns and, ironically, risk. The high levels of liquidity injected into markets around the world, if not managed correctly, risk future inflation. A pick-up in inflation will push interest rates higher and this will negatively affect the pricing of bonds and risk capital losses to bond investors.
US 10 Year Treasury Bond Yield – 20 YEARS
There remains a high degree of uncertainty regarding the impact of the pandemic and what the respective governmental responses will have on economies around the world. Some sectors of the global economy may never return to the pre-pandemic normal. This means that growth in other sectors will be required in order to absorb the millions of job losses accumulating by the week. Government policy makers will need to support those sectors of the economy where future jobs are likely to come from.
What is encouraging for investors is that fiscal and monetary policy has evolved significantly over time. The 2008-2009 Global Financial Crisis proved that policy makers can respond effectively to a crisis. The difference between the current COVID crisis and the GFC is the speed and scale of the response and interventions. Markets have become accustomed to, and expect monetary policy and other interventions to save the day and prevent a catastrophe. This goes a long way to explain the V-shaped recovery in markets which is at odds with what is happening in the real economy.
GLOBAL INDICATORS: Local reporting currencies