Tug-of-war between stock market optimism and economic realism
After a strong stock market week, including new all-time highs for the tech-heavy Nasdaq exchange in the United States and a market rally in China, US stocks traded down somewhat yesterday. Continued stimulus measures and positive economic data have been offsetting news of increased coronavirus spread in many countries. Several purchasing managers' indices and American labour market data turned out better than expected. In the coming weeks, stock market performance will depend on whether second quarter corporate earnings reports also confirm the recovery reflected in various economic indicators.
Positive American labour market, but continued coronavirus spread
In the US, confirmed new COVID-19 infections have been setting new daily records. In testimony to a Senate committee Dr Anthony Fauci, the leading White House infectious diseases advisor, warned that the number of new cases could double to 100,000 per day unless behaviours change and public authorities do more to prevent the disease from spreading. Meanwhile he was "cautiously optimistic" that a vaccine may be available by early 2021. Despite the crisis, President Trump has formally moved to pull the US out of the World Health Organisation (WHO), effective on July 6, 2021.
According to official American labour market data, employment fell by a record 20 million in April. But the May figure surprised all forecasters, by showing a sharp increase instead of a further drop. The June figure continued this positive trend, with 4.8 million new jobs and a decline in unemployment to around 11%, after having reached nearly 15% in April. This indicates that the US labour market will improve as the economy reopens following coronavirus-related lockdowns.
Chinese media fuelling domestic stock market upturn
During the past week, Asian equities have been sustained by statistics showing economic recovery. This included rising Chinese purchasing managers' indices, while South Korea's exports and imports both shrank less in June than in each of the preceding two months and the country's trade balance improved. More surprising is that the trading volume on China's stock exchanges surged by 130% above recent averages, according to the Financial Times. Since several state-owned Chinese media companies have simultaneously urged investors to buy equities, the rally appears to be the result of a coordinated effort to re-ignite the market.
This may lead to major risks, however, once the authorities assume that the market has reached the "right" level and try to tone down the rhetoric. The current market upturn is strengthening investor optimism, but at the price of increased potential for setbacks. The market mood may also rapidly worsen if US-Chinese tensions escalate, especially after China's new security law went into effect − causing the US Congress to approve sanctions against businesses and individuals that help China restrict Hong Kong's autonomy. Several news reports overnight show that China is continuing to tighten its grip on Hong Kong and will set limits on pro-democracy movements by opening a Beijing-controlled security office there.
Will Putin be president for life?
Russia held a referendum asking voters to approve some 200 constitutional amendments, combined in a single Yes/No package. This included removing the two-term limit on an incumbent president (which the State Duma had already approved) and thus allowing Vladimir Putin to run for president again in 2024 and potentially remain in office until 2036, when he will be 83 years old. The extensive package of amendments also indexes pensions to inflation, guarantees access to health care, bans same-sex marriage and upgrades the status of the Russian language.
From an economic perspective, the result of the referendum is likely to be stagnation, since reforms aimed at reducing the role of government and revitalising the Russian economy might be conspicuously absent for another 16 years.
Swedish key interest rate will stay at zero until 2023
As expected, Sweden's Riksbank left the key interest rate unchanged. Its own forecasts indicate that the repo rate will stay at zero until at least the third quarter of 2023. Instead the central bank will support economic growth by making more bond purchases − extending its bond-buying programme from the end of 2020 until summer 2021 and boosting volume from SEK 300 billion to SEK 500 billion. The Riksbank also announced that it will start buying corporate bonds in September. Our main scenario is that the key rate will remain unchanged for a long time, and the latest signals from the Riksbank confirm this picture.
Our market view
Uncertainty about the effects of new and continued coronavirus outbreaks may cause some stock market instability, but continued stimulus – such as central bank bond purchases and government fiscal packages – will help to sustain risk appetite. The weaker economies become, the higher the probability that central banks and governments will provide even more support, but if downturns are milder, corporate earnings will recover faster and share prices can then climb without such support.
We expect continued low interest rates and bond yields − along with a slow return to more normal growth trends − to help sustain the stock market. We thus have a cautiously optimistic view of risk assets such as equities and high yield corporate bonds, and we are maintaining our hypothesis that stock market downturns can be regarded as buying opportunities.
Our weekly Market Outlook will now take a summer break and will return in mid-August. We wish our readers a relaxing and enjoyable summer after an intensive spring, so that everyone will come back with renewed energy.
We and our colleagues will of course keep an eye on the markets even during the summer holiday period and will provide you with extra market commentaries if necessary.