Category: Markets & Economy

A look back at markets in August when hopes of a Covid-19 vaccine and a shift in Federal Reserve policy helped to support shares.

• Shares were broadly higher in August amid hopes for a Covid-19 vaccine, signs of continued economic recovery and ongoing policy support measures. Government bond yields rose (meaning prices fell).  
• US equities – as represented by the S&P 500 – reached a new peak. The Federal Reserve confirmed its readiness to offer further support, while increasing its flexibility to do so by adjusting how it targets inflation.
• Eurozone shares rose. Top performing sectors included economically-sensitive areas like industrials and consumer discretionary. There were concerns about rising Covid-19 infections in some countries, notably Spain.
• UK shares also gained. Signs there could be a solid recovery in the domestic economy during Q3 2020 helped UK small and mid cap equities play a supportive role for the market over August.
• Japanese shares gained too. Late in the month, Shinzo Abe announced his resignation as prime minister, citing a long-standing health problem.
• Emerging market (EM) equities recorded a positive return as hopes for a Covid-19 vaccine increased, and on the Federal Reserve’s suggestions that US interest rates could remain low for longer.
• In fixed income, government bond yields rose (meaning bond prices fell) and the US dollar continued to decline. Corporate and emerging market bonds performed well.
• In commodities, precious metal prices rose with US dollar weakness providing a strong tailwind.

Please note any past performance mentioned is not a guide to future performance and may not be repeated. The sectors, securities, regions and countries shown are for illustrative purposes only and are not to be considered a recommendation to buy or sell.

US

US equities – as represented by the S&P 500 – reached a new peak in August, in spite of tensions between the US and China escalating. What began as the two nations exchanging trade blows has now developed into restrictions on diplomats and military posturing. However, the ongoing stand-off was overshadowed through the month by economic data, which, while patchy, suggests that the economic recovery continues.

The Federal Reserve (Fed) also confirmed its readiness to offer further support, while increasing its flexibility to deliver it by adjusting its measurement of inflation. Although the Fed anticipates inflation to remain “soft”, it is also adopting “average inflation targeting” to allow temporary tolerance of increases beyond the 2% target.

Year on year inflation (core CPI) rose to 1.6% (in July) from a trough of 1.2%, driven by a continued reversal of gasoline prices – which rose by 5% in July – as well as higher prices for apparel, used cars and airfares. In the meantime, the number of Americans applying for unemployment benefits fell below 1 million for the first time since the pandemic began in March. However, retail sales in July increased by less than expected and consumer confidence remains subdued.

The IT sector was again a notable contributor to the market’s overall gains in August. Sectors exposed to an improving economic cycle, such as industrials and consumer discretionary, also rose. Utilities and real estate were weaker areas, as were energy stocks.

Eurozone

Eurozone equities notched up gains in August but lagged behind other regions. Top performing sectors included economically-sensitive areas of the market like industrials and consumer discretionary. The healthcare sector was among the laggards, after a strong performance so far this year, as investors favoured parts of the market deemed more likely to benefit from economic recovery. Within individual industries, automakers were buoyed by data showing rising car sales in China. The Q2 earnings season concluded and was overall better than expected. The euro strengthened further against the US dollar.

Data confirmed that the eurozone economy contracted by -10.1% in Q2. However, the German economy’s fall was revised to a smaller decline of -9.7% from -10.1% previously. There was continuing unease about rising Covid-19 infections in some countries, notably Spain and France, with various countries imposing some form of travel restrictions. Meanwhile, Germany extended its scheme to top up the pay of workers affected by the pandemic; this was due to expire in March 2021 but will now run until the end of next year.

Recovery momentum slowed, according to the latest purchasing managers’ indices (PMIs). The composite index for August reached 51.6 compared to 54.9 in July. (50 is the level that separates expansion from contraction. The PMI surveys are based on responses from companies in the manufacturing and services sectors).

UK

UK equities rose over the period as risk appetite recovered generally due to the improving global growth outlook. Signs there could be a solid recovery in the UK economy over Q3 2020 were also supportive of small and mid cap (SMID) equities. As a result, the market recouped some of its losses from July when fears around a second wave of Covid-19 infections had dominated sentiment.

The market was led higher by economically-sensitive areas, including some of the sectors where activity had been hit hardest during the pandemic. Corporate news in many of these sectors improved and began to reflect the more encouraging macroeconomic data seen over the summer. These trends contributed to the outperformance of domestically-focused equities and UK SMIDs at a time when sterling strength against a weak dollar weighed on internationally-exposed large caps.

The summer rebound in UK economic activity, helped by fiscal policy support and a relatively milder resurgence in new Covid-19 cases versus some other territories, could set the UK up for a solid recovery over Q3. A potential pick-up in job losses remains the big unknown. While the latest data from the Office for National Statistics confirmed that the UK economy had entered a recession in Q2, the market focused on news that monthly GDP had grown by 8.7% in June 2020, supporting hopes for a reasonably sharp Q3 rebound.

Japan

In August, the Japanese equity market quickly regained the ground lost at the end of July, then traded sideways for the rest of the month to end 8.2% higher. Speculation over the potential resignation of Prime Minister Abe arose during market hours on Friday 28 August, and caused a small dip in share prices. His resignation was confirmed later that day and, by the end of trading on Monday 31 August, the market was basically unchanged across the two days. The yen did strengthen on the announcement but, for the month as a whole, there was a small net weakening against most major currencies.

Shinzo Abe’s resignation, due to the resurgence of a long-standing health problem, came just four days after he recorded the longest continuous term of any Japanese prime minister. His popularity has declined recently, primarily due to his handling of Japan’s response to the pandemic. In recent weeks, an uptick in new infections cases, albeit from a very low base, has led to further criticism of perceived policy inconsistencies. The LDP has now opted for the simplest method by which their next party president can be elected, and this is likely to take place on 14 September. Yoshihide Suga, currently Chief Cabinet Secretary, has emerged as the front-runner in early September.   

Away from politics, although corporate profits are clearly under pressure, the recent quarterly earnings season brought more positive surprises than might have been expected. The pandemic has made it very hard to form a clear consensus for earnings, with many companies unwilling to provide their usual guidance due to the extreme uncertainty. However, on our estimates, around 40% of companies beat market expectations, with 40% in line and 20% underperforming. This compares to a more typical split of roughly one third in each category. Economic data released in the last few weeks has also been slightly skewed to positive surprises, especially in industrial production which saw a larger rebound than expected.

Asia (ex Japan)

The MSCI Asia ex Japan index posted a strong return, aided by hopes for a Covid-19 vaccine and ongoing economic recovery, as well as US dollar weakness. The index was led higher by strong performances from China and Hong Kong SAR, where Covid-19 infection rates fell and most sectors advanced. In China, upside surprises in Q2 earnings results boosted sentiment, and exports expanded strongly, though there were rising tensions with the US. Although China’s commitment to Phase I of the US-China trade deal was a positive, other tensions included sanctions on technology giant Huawei by the US.

Meanwhile, China and India had their own border skirmishes near month end, leading India to give back some of its strong performance generated earlier in the month. Nevertheless, India performed broadly in line with the index, despite the continued rise in Covid-19 cases.

Conversely, Malaysia, Thailand and Taiwan finished in negative territory and were the weakest index performers. Taiwanese equities fell amid weakness among IT stocks. Apple supply chain stocks in particular were negatively impacted by the US-China tensions.

Emerging markets

Emerging market (EM) equities recorded a positive return as hopes for a Covid-19 vaccine increased, and as the Fed’s new monetary policy strategy suggested that interest rates could remain low for longer. The MSCI Emerging Markets Index increased in value but underperformed the MSCI World Index

Egypt was the best-performing market in the MSCI Emerging Markets Index. China outperformed as stronger-than-expected Q2 earnings results, notably in the e-commerce sector, boosted sentiment. This was despite an escalation in US-China tensions.

A pick-up in materials and energy prices was supportive of net exporter EM countries including Peru, the UAE, Saudi Arabia and Qatar, all of which outperformed the index. The reciprocal UAE-Israel diplomatic recognition also boosted sentiment towards Middle Eastern markets. India finished ahead of the index. This was despite further acceleration in daily new cases of Covid-19, and renewed tensions on its border with China on the final day of the month.

By contrast, Chile and Brazil finished in negative territory and were the weakest index markets, with weakness amplified by currency depreciation. Turkey, where lira weakness amplified negative returns, and to a lesser extent Taiwan also underperformed.

Global bonds

Investor sentiment and risk appetite remained strong in August. Government bond yields rose (bond prices and yields move inversely of each other) and the US dollar continued to decline, while corporate and emerging market bonds performed well.

Investors shrugged off further concerns over Covid-19 with the focus on the Federal Reserve’s annual conference at Jackson Hole late in the month. The Fed, significantly, announced that it would tolerate higher inflation, dispensing with its 2% target in favour of a 2% average level. This strengthened investor expectations that highly accommodative monetary policy will remain in place for a long time yet. The global economy showed further signs of modest recovery.

The US 10-year Treasury yield rose by 18 basis points (bps) to 0.70% over the month, while in Europe, Germany’s 10-year yield was 13bps higher at -0.40%, with France’s rising by 10 to -0.10%. Italy and Spain outperformed, with their 10-year yields rising by eight and seven bps respectively. The UK 10-year yield rose by 21 points to 0.31%.

Corporate bonds outperformed government bonds. High yield credit led amid strong risk appetite, with a continued rebound in those sectors most impacted by Covid-19, such as leisure. Investment grade corporate bonds saw negative total returns (local currency) due to rising yields. Investment grade bonds are the highest quality bonds as determined by a credit rating agency; high yield bonds are more speculative, with a credit rating below investment grade.

Emerging market (EM) government and corporate bonds (hard currency) produced further positive returns, though at a more moderate pace, led by high yield. Local currency denominated EM debt was slightly lower and there were mixed performances from EM currencies. The Mexican peso, Chinese yuan and Indian rupee gained against the dollar, while the Brazilian real and Turkish lira weakened.

The Thomson Reuters Global Focus index, which measures convertibles, was up 2.6% this month compared to a 6% gain for the MSCI World equity index. Convertibles were in demand by global investors and valuations became more expensive – especially in the technology heavy US segment of the market.

Commodities

The S&P GSCI (commodities index) registered a positive return. Agriculture was the strongest component, with corn and soy beans recording particularly robust returns. Energy and industrial materials components also delivered strong gains. Energy price rises were driven by increased demand as economic activity continued to pick up globally. Nickel and zinc drove gains in industrial metals, amid increased demand from China. In precious metals, silver continued to generate stellar gains while gold slightly lost ground.

The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.

A review of markets in May when shares were supported by an increasing focus on how lockdowns would be lifted.

• Equity markets rose on the whole in May as Covid-19 lockdown measures began to be lifted and further support measures were announced. Escalating tensions between the US and China, however, limited emerging market equity gains.
• US shares gained ground amid optimism over the re-opening of the economy. Q1 GDP growth was revised down to -5.0%, compared to the first estimate of -4.8%.
• Eurozone equities advanced as some countries began to allow some parts of their economies to reopen. The European Commission proposed a €750 billion recovery package.
• UK equities rose in May. A number of economically sensitive areas performed well amid the improvement in investor sentiment. Sterling fell as worries over a no-deal Brexit resurfaced.
• Japanese shares posted gains, with pharmaceutical stocks leading the advance. Lockdowns across the country were lifted in stages during the month.
• Emerging market (EM) equities advanced but underperformed developed markets. Performance was dampened by the re-emergence of US-China tensions.
• Corporate bonds outperformed government bonds as the more optimistic backdrop saw investors favour higher risk assets. US 10-year government bond yields were little changed during the month.

Please note any past performance mentioned is not a guide to future performance and may not be repeated. The sectors, securities, regions and countries shown are for illustrative purposes only and are not to be considered a recommendation to buy or sell.

US

US equities gained in May, with investors cheered by plans to ease the Covid-19 lockdown measures both domestically and in many countries around the world. Every US state had made plans to reduce restrictions by mid-May. The US dollar fell, becoming less attractive as a safe haven as risk appetites climbed. The rise in optimism came in spite of the confirmation that the economy had contracted by slightly more than expected in Q1.

Real GDP for Q1 was revised down to an annual rate of -5.0%, a bigger decline than the 4.8% drop first estimated. It was the biggest quarterly drop since an 8.4% fall in Q4 2008. Much of the weakness was due to a sharp fall in consumer spending, especially in consumer purchases of services. In addition, there were some concerns that the US-China trade relationship could sour again. However, neither issue managed to recapture investor focus, which landed on economies restarting around the world.

US equities rose in line with other world equity indices. All sectors in the S&P 500 rose with materials and industrials, more cyclically-exposed, performing strongly. IT stocks were once again notable outperformers. Consumer staples and energy lagged behind the wider market but still made positive progress.

Eurozone

It was another month of gains for eurozone shares in May as many European countries began to ease out of lockdown. Stock markets were further supported by news of the EU’s plans for post-coronavirus recovery.

European Commission president Ursula von der Leyen called for the power to borrow €750 billion for a recovery fund to support those EU regions that have been worst affected by Covid-19. This would be in addition to the €540 billion rescue package agreed in April. She also proposed a new suite of taxes to pay back the debt. The plan still needs the approval of member states, with the recovery fund expected to be on the agenda for the 19 June European Council summit. In addition, comments from European Central Bank (ECB) board members suggested that the ECB’s asset purchase target could be increased at the June meeting.

All sectors saw positive returns with gains for both economically-sensitive sectors and those perceived to be more defensive. The industrials and utilities sectors were among the top gainers while energy and consumer staples saw a smaller advance. Forward-looking economic data showed how activity is picking up as lockdowns started to be relaxed: the Markit composite purchasing managers’ index (PMI – a survey of companies in the manufacturing and service sectors) rose to 30.5 in May from 13.6 in April. However, this is still well below the 50 mark that separates expansion from contraction.

UK

UK equities rose over the period. A number of economically-sensitive areas of the market outperformed amid the general improvement in investor sentiment. The mining sector performed particularly well in response to a recovery in Chinese industrial activity.

The government began to ease lockdown measures with people encouraged to return to work where possible and a phased reopening of the retail industry and schools confirmed. Meanwhile, the UK’s departure from the EU returned to the agenda as the end of June deadline to extend the Brexit transition period, which expires on 31 December 2020, came into view.

Renewed concerns that the country could be heading for a “no deal” Brexit weighed on sterling, as did the prospect of negative interest rates. The Bank of England governor told parliamentarians that negative rates were under “active review” while the Debt Management Office confirmed it had sold negative yielding gilts for the first time.

The Office for National Statistics reported that the UK economy had contracted by 2% in Q1 2020 as lockdowns in response to the Covid-19 pandemic took their toll on activity towards the end of Q1. The preliminary estimate was less negative than consensus estimates, though it does represent the largest fall in GDP since the fourth quarter of 2009 and the global financial crisis.

Japan

The Japanese market rose steadily for most of May to end with a positive total return of 6.8%. The yen was quite stable, weakening just marginally against the US dollar during the month.

Equity investors globally have responded to an assumed reopening of economic activity, although the actual path for any return to a more normal environment for corporate earnings remains very uncertain. The Japanese market was led up in May by pharmaceuticals. There was a brief recovery for some financial stocks, including leasing companies, together with airlines, which have been among the hardest hit sectors throughout this crisis. Small caps also performed relatively well and have now recouped almost all of the underperformance seen from January to mid-March.

The results season concluded for the fiscal year, which ended in March. Investors have naturally focused more on the outlook than the historical results, but only a minority of companies have provided any guidance for the fiscal year to March 2021. 

Japan’s statistics on both the infection rate and the mortality rate from coronavirus remain significantly better than most other developed economies. The population seems to believe this is more by luck than judgement on the part of the government: the public’s approval rating of Abe’s administration has fallen to its lowest levels since he became prime minister at the end of 2012. Nevertheless, the prime minister was able to announce a staged lifting of the state of emergency, starting from 14 May for some prefectures and culminating on 25 May for Tokyo. Abe’s cabinet drew up a second supplementary budget in May, as expected.

Asia (ex Japan)

Asia ex Japan equities bucked May’s global market trend by posting a loss.  Hong Kong, where a new national security law was proposed, was the worst-performing market in the region. The other Greater China markets of China and Taiwan also posted losses as Beijing’s relationship with the US became strained once again amid talk of delisting Chinese companies from US markets and imposing compensatory tariffs for Covid-19.

Elsewhere, India, where the financial sector was as drag, also posted a loss, so too did Singapore. Meanwhile, a better-than-expected earnings season boosted the Korean market, while the ASEAN (Association of Southeast Asian Nations) markets of Thailand and Malaysia also posted strong gains. Across the region, the worst-performing sectors were real estate and financials, while healthcare and consumer discretionary outperformed.

Emerging markets

Emerging market (EM) equities registered a positive return in May, as lockdowns began to ease worldwide, although performance was dampened by the re-emergence of US-China tensions.

Argentina was the best-performing index market. Brazil, where the central bank promised to intervene to support the currency if necessary, and Russia, aided by currency strength and a rally in crude oil prices, also outperformed.

Chile and Egypt, which sought additional support from the International Monetary Fund (IMF), were the weakest index markets. China also lagged behind as the intensifying US-China confrontation expanded beyond trade and technology issues to broader geopolitical tensions and China moved to impose a national security law on Hong Kong.  

Global bonds

Investor optimism grew over the month, with riskier assets performing well. The rate of new Covid-19 infections continued to moderate and various countries started to ease lockdown measures.

Central banks gave assurances that support would continue and, in Europe, there was progress towards a co-ordinated agreement on fiscal support measures. Economic activity data showed some improvement, with higher frequency indicators suggesting the situation is less dire than widely feared. These factors outweighed concerns over renewed tensions between the US and China.

The 10-year US Treasury yield was little changed at 0.65%, trading in a relatively tight range throughout the month. The two-year yield finished slightly lower.

In comparison, European government yields saw meaningful moves, reflecting developments around potential fiscal support. Germany’s 10-year yield rose from -0.59% to -0.45%, while Italy’s fell from 1.76% to 1.49%. The Spanish 10-year yield fell from 0.73% to 0.57%.

The UK 10-year yield was slightly lower, from 0.23% to 0.18%, while sterling weakened. UK yields fell below zero in shorter maturities, reacting to speculation that the Bank of England might be considering employing negative interest rates. The UK’s two-year gilt yield fell from 0.01% to -0.04%.

Corporate bonds outperformed government bonds, with global high yield (HY) returning 4.5% (source: BofAML, local currency) amid stronger demand for riskier assets. The spread on HY (the difference in the yield of a corporate bond versus a similar maturity government bond) tightened by 107 basis points (bps). Investment grade saw total returns of 1.3% (source: BofAML, local currency). Across both, positive performance was driven predominantly by cyclical sectors, which continued to recover ground. Investment grade bonds are the highest quality bonds, as determined by a credit ratings agency, while high yield bonds are more speculative, with a credit rating below investment grade.

The increased demand for riskier assets also led to positive returns for emerging markets bonds and currencies, led by higher yielding markets. Currencies of oil exporters made gains as oil prices recovered. The Mexican peso and Russian rouble were among the strongest performers.

The overall MSCI equity index returned 4.5% in May. Convertible bonds as measured by the Thomson Reuters Global Focus Index, outperformed stocks with a gain of 5.4%. There was a record volume of new issues with $26 billion of new paper which kept valuations low.

Commodities

There was a bounce-back in commodities markets in May. This was led by oil as Brent rose by 40% amid a loosening of lockdown measures in many countries. Precious metals, led by silver (+19.3%), and industrial metals, led by iron ore (+10%), also gained.

The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.