Small bright spots amid depressed data
We still believe that the first two quarters of 2020 will be the worst for the economy, but some of the statistics published this past week have shown certain bright spots.
In Asia, rising purchasing managers' indices in China indicate a continued economic recovery after the worst of the COVID-19 pandemic there, although the situation remains far from normal. Meanwhile a 24% year-on-year decline in South Korean exports during May demonstrates that the crisis is not over.
April new home sales in the US were about the same as in March, which was far above expectations. Meanwhile last week's American jobs data showed a continued decline in the number of initial claims for unemployment assistance since the peak in late March. More than 40 million people have sought such benefits over the past 10 weeks. Although some of them have found other work or returned to their old jobs, US unemployment has probably not peaked yet. This coming Friday, the official US jobless figure for May will be reported; it is expected to climb from almost 15% in April to nearly 20%.
In purely practical terms, more countries are taking steps that may boost consumption again. This past week, restaurants have reopened (with some virus-related restrictions) in countries like France, Luxembourg and Spain. Germany will lift its warning on travel to and from other European countries starting June 15. Italy is opening its borders to travellers from other European Union countries and the United Kingdom today. The UK gave the green light to outdoor markets on June 1 and will allow department stores to reopen on June 15. One downside macroeconomic risk is that even if countries reopen retail trade, it will take some time before consumption reverts to earlier levels.
More economic stimulus measures
Governments and central banks are continuing to deliver powerful stimulus measures. Japan has launched a new fiscal package. China is taking steps to support lending by local banks to small and medium-sized businesses.
The EU has proposed a recovery fund that would borrow jointly in order to supply EUR 500 billion in grants, but EUR 250 billion in loans have now been added to the package. The money would begin to be distributed in September, but the proposal requires approval by all 27 EU member countries, and not all of them agree. Considering the depth of the economic crisis, we believe that the fund will become a reality, but probably after various concessions to the countries that now oppose it. Intensive negotiations are likely before the European Council meets on June 18-19 to make its decision. We also expect the European Central Bank to approve a continued high level of stimulative bond purchases at its policy meeting tomorrow (Thursday, June 4).
Increased US-Chinese tensions
At last week's meeting of its National People's Congress, China announced plans to enact new security legislation in Hong Kong. In the US, the Trump administration responded by saying it is considering various new sanctions against Chinese official representatives, companies and financial institutions. President Donald Trump's announcement was not as far-reaching as feared, but rising US-Chinese tensions are contributing to a negative undertone. According to Reuters, China is retaliating by ordering state-owned companies to halt their purchases of US farm products. Looking ahead, there is a risk that the progress achieved in last year's US-Chinese trade talks will unravel, but the Phase 1 deal does not yet appear to be under serious threat.
Our market view
Stock markets are continuing to climb. News of fresh stimulus measures, especially from the European Union, and signs that economic growth may be bottoming out are driving market performance and undoubtedly justify the rebound in share prices that occurred after dramatic declines in March. But the scale of the rebound is a source of concern.
Because of the economic slowdown, corporate earnings forecasts for 2020 are being revised sharply lower. From expectations of earnings increases around 10% globally a couple of months ago, forecasts are now pointing to declines of around 25%. Most observers, including us, expect earnings to regain lost ground during 2021, probably also setting the stage for earnings to continue increasing after next year. This would justify high valuations. But already driving up share prices towards their earlier peaks, at the same time as earnings are falling sharply, is challenging.
We are forecasting that economic growth will rebound starting in the second half of 2020. This scenario, combined with continued low interest rates, lays a good long-term foundation for equities. An optimistic stock market view today focuses on the brighter long-term outlook and maintains that current historically stretched share price valuations are also justified by continued low interest rates and bond yields.
We share this view of long-term fundamentals and see reasons for slightly higher valuations, but in the short run there are still many risks of disappointments. The rapid upturn makes the market more sensitive to negative news about economic growth and corporate earnings. But as long as current headlines on continued stimulus measures and promising signs about reopening economies persist, the positive stock market trend will continue.
Please contact your private banker if you have any questions or concerns.