Asia In Demand

Equity markets managed to shake off Covid concerns at the end of last week despite virus cases in the US reaching a record high and Europe battling a full-blown second wave; S&P 500 and Russell 2000 hit record highs.  Asian equities started the week building on this positive momentum.  Helping markets was the news that advisors to President-elect Joe Biden have said they oppose a nationwide US lockdown despite the sharp rise in virus cases.  This will help allay fears that the US economy will weaken sharply over the next few months amid severe lockdowns and before a vaccine can be distributed.

Vaccine enthusiasm will likely play against Covid escalation in the days and weeks ahead. In the near-term slim chances of a sizeable US fiscal stimulus taken together with a more rapid increase in global Covid infections highlight clear risks to risk assets, and this may be enough to put roadblocks in place at a time when various equity indices are reaching key technical levels.  Conversely, it is too early to write the US dollar off in the short term even if the medium-term trend is likely to be downwards. 

Asia remains favoured within emerging markets, as the virus has come under control across most of the region.  News of the signing of the Regional Comprehensive Economic Partnership (RCEP) trade deal by 15 countries in the region after 8 years of negotiations, but without the US and India, provides another boost to regional economic and market prospects.  The deal is less extensive than the Trans-Pacific Partnership (TPP) as it removes around 90% of tariffs rather than 100% under TPP.  Nonetheless, it is estimated that the deal could boost the global economy by close to $200bn by 2030.  Although the deal still has to be ratified by a number of countries it is a step closer to a unified trade block like the EU.   

Additionally, Chinese data today ought to be supportive for regional assets even amid the threat of further sanctions by President Trump’s administration in the weeks ahead. China’s October activity data including industrial production fixed assets investment, property investment and the jobless rate were on balance positive, showing that China’s economic recovery is gathering steam.  The data will likely provide further support to China’s markets including China’s currency, though it effectively seals the case for no further easing by China’s central bank, PBoC, while giving the rest of Asia more fuel to rally. 

Over the rest of the week emerging markets central banks will garner most attention, with a plethora of policy rate decisions on tap.  Hungary (Tue), Thailand (Wed), Philippines (Thu), South Africa (Thu), and China (Fri) are set to keep policy rates on hold while Indonesia (Thu) is likely to cut by 25bps and Turkey is expected to hike its policy rate by 475bp hike (Thu).   Turkey in particular will be a focus in this respect given the replacement of central bank governor and the more than 10% rally in the Turkish lira last week.

Markets Facing a Test of Reality vs. Liquidity

Risk assets ended last week under pressure (S&P 500 fell 2.4%) as some US states including Texas and Florida began to reverse opening measures and Anthony Fauci, the infectious diseases expert, warned that some states may have to return to full “shelter in place”.  Banks were among the worst performers even as they came through the Fed’s stress tests in reasonably good shape.  The Fed did however, cap buybacks and dividend payouts for the 33 banks that underwent tests. However, the reality is that banks were hardly likely to increase dividends over the next few months, while the 8th biggest banks had already suspended buybacks.  Perhaps what spooked markets was the news of “additional stress analyses later in the year”.

It feels like equities and risk assets in general are facing a test of reality vs. liquidity. It’s hard to fight the growth in excess liquidity global (G4 central bank balance sheets minus GDP growth) which has risen to its highest rate since Sep 2009, coinciding with a solid run in global equities over that period.  Clearly forward earnings valuations have richened but while absolute valuations appear rich (S&P forward price/earnings ratio has risen to 24.16), relative valuations ie compared to low global rates, are more attractive. This hasn’t stopped the intensification of concerns that after a solid market rally over recent months, the entry of a range of speculative investors is leading to a Minsky Moment.

Investor concerns range from the fact that the rally has been narrowly based, both in terms of the types of investors (retail investors piling in, while institutional have been more restrained) and type of stocks (momentum vs. value), the approach of US Presidential elections in November and in particular whether there could be a reversal of corporate tax cuts, as well as the potential for renewed lockdowns. Add to the mix, geopolitical concerns and a certain degree of market angst is understandable. All of this is having a growing impact on the market’s psyche even as data releases show that recovery is progressing somewhat on track, as reflected for example in the New York Fed’s weekly economic index, which has continued to become less negative and the Citi Economic Surprise Index, which is around its highest on record.

China, which was first in and now looks to be first out is a case in point, with growth data showing ongoing improvement; data today was encouraging, revealing that industrial profits rose 6% y/y in May though profits in the first five months of the year still fell 19.3%, with state-owned enterprises recording the bulk of the decline.  While there are signs that Chinese activity post-Covid is beginning to level off, domestic consumption is gradually improving. This week, market activity is likely to slow ahead of the US July 4th Independence Day holiday but there will be few key data highlights that will garnet attention, including June manufacturing PMIs in China and the US (ISM), and US June non-farm payrolls.

Fundamentals Versus Liquidity

Markets took fright last week. The divergence between what fundamentals are telling us and what markets are doing has widened dramatically, but bulls will say don’t fight the Fed.  However, after an unprecedented run up from the late March lows, equity markets and risk assets appeared to react negatively to a sober assessment of the economic recovery by Fed Chair Powell at last week’s FOMC meeting. News of a renewed increase in Covid-19 infections in several parts of the US against the background of ongoing protests in the country, added to market nervousness.  On Thursday stocks registered their biggest sell off since March but recovered some composure at the end of the week. Volatility has increased and markets are looking far more nervous going into this week.

Exuberance by day traders who have been buying stocks while stuck in lockdown, with not much to do and government pay outs in hand, have been cited as one reason that equities, in particular those that were most beaten up and even in Chapter 11 bankruptcy, have rallied so strongly.  Many (those that prefer to look at fundamentals) believe this will end in tears, comparing the run up in some stocks to what happened just before the tech bubble burst in 2000/01.  The reality is probably somewhat more nuanced.  There’s definitely a lot of liquidity sloshing around, which to some extent is finding itself into the equity market even if the Fed would probably prefer that it went into the real economy.   However, buying stocks that have little intrinsic value is hard to justify and market jitters over the past week could send such investors back to the sidelines.

Stumbling blocks to markets such as concerns about a second wave of virus infections are very real, but the real question is whether this will do any more damage to the economy than has already happened.  In this respect, it seems highly unlikely that a second or even third round of virus cases will result in renewed lockdowns.  Better preparedness in terms of health care, contract tracing, and a general malaise from the public about being locked down, mean that there is no appetite for another tightening in social distancing restrictions.  The result is a likely increase in virus cases, but one that may not do as much economic damage.

Last week’s equity market stumble has helped the US dollar to find its feet again.  After looking oversold according to various technical indicators such as the Relative Strength Index (RSI) the dollar rallied against various currencies recently.  Sentiment for the dollar had become increasingly bearish (overly so in my view), with the sharp decline in US yields , reduced demand for dollars from central banks and companies globally amid an improvement in risk appetite weighing on the currency.  However, I think the dollar is being written off way to quickly.  Likely US economic and asset market outperformance suggests that the US dollar will not go down without a fight.

Opening Up

Attention is squarely going to be on efforts to open up economies in the days and weeks ahead.  Most US states are opening up to varied degrees while the same is happening across Europe.  The risk of course is that a second or even third wave of Covid-19 emerges for some countries, as is being seen in some parts of Asia, for example Korea where renewed social distancing measures have been put in place after a fresh cluster of cases in clubs and bars there.

However, governments will need to weigh up these risks against the growing economic costs of lockdown, which will by no means be easy.  Even as social distancing and lockdown measures are eased, it will likely be a gradual process, with activity likely to remain under pressure.  This is when the real test for markets will take place.  While markets have clearly been buoyed by unprecedented stimulus measures, especially from the Federal Reserve, which could continue for some time, fiscal injections will run their course over the next couple of months.

As revealed in April US jobs data at the end of last week the costs in terms of increased unemployment has been severe. The US unemployment rate hit a post war high of 14.7% while 20.5 million people lost their jobs.  This news will be echoed globally. Markets were expecting bad news and therefore the reaction was limited, but the data will nonetheless put more pressure on policy makers to keep the stimulus taps open.  Discussions are already in place between US Republican and Democrats over a new package, though disagreements on various issues suggest a deal may not happen soon.

Another spanner in the works is tensions between the US and China.  The US administration has become more vocal on blaming China for the virus, over recent weeks.  This had threatened to undermine the “phase 1” trade deal agreed a few months ago.  However, there were some soothing remarks on this front, with a phone call between senior US and Chinese officials last week, highlighting “good progress” on implementing the deal.  Despite such progress, it may not calm tensions over the cause of the virus, especially ahead of US elections in November and markets are likely to remain nervous in the weeks ahead.

This week there will be more evidence on tap to reveal the economic onslaught of the virus, just as many countries are finally flattening the virus curve itself.   Q1 GDP releases will reveal weakness in several countries.  Chinese activity data including retail sales and industrial production as well as credit metrics will give further evidence of the virus impact and how quickly China is recovering.  If anything, China’s recovery path will likely show the pain ahead for many economies that are easing lockdown measures.  In the US, inflation data and retail sales will garner attention.  In terms of central banks attention will be on the Reserve Bank of New Zealand (RBNZ). While no change in policy rates is likely a step up in the RBNZ’s asset purchases may take place.

 

 

 

 

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