Market View – The Old Normal
Our caution last month proved to be unfounded. The power of the unprecedented stimulus, zero interest rates and the prospect of loosening of lockdown restrictions won the battle against extreme lows in economic activity and the prospect of worst economic data to come. As a result, the World MSCI Index is up 14% since mid-April, and up a whopping 43% since the March trough. The Index now sits at only 6% below the pre-COVID peak. Virtually all risk assets moved up in tandem, including credit. Even oil staged a big rally, rising to USD38 per barrel. The confirmation that the market hadn’t lost all sense occurred last Friday when US unemployment fell to 13.3%, a 1.4% decline from the April figure. This was a particularly large positive shock since some commentators were fearing a number closer to 20%. The other shoe has yet to fall, and those that are waiting, may be in for a long wait. Last week the US interest rate curve steepened 15-25bp for 5-10Y.
Despite market movements, the world is not yet back to normal. The trend in new COVID infections globally is actually still rising. However, the regions that concern the financial markets, namely US and Europe, there the trend is falling, even if the fall is stubbornly slow. Significant restrictions still apply in most countries. The daily new cases in the US still number approximately 19,000, a large quantum.
Source: JHU CSSE
Act 4 in a 5 Act Play
We are now in the 4th Act of the expected 5 Act COVID play for equity markets. The Acts can be characterised as:
Act 1: 3rd week of February. Stocks and other risk assets begin to sell off indiscriminately. The culmination of the first Act was the implementation of the lockdown and social distancing that resulted in the market trough on the 23rd of March.
Act 2: Last week of March. The market realized that there were beneficiaries to the austere policies and we witnessed share prices for online businesses start to surge.
Act 3: 1st week of April. Interest swung to quality businesses that were not beneficiaries of the policies but were partly resistant to the situation and would survive largely intact.
Act 4: Mid-May. The 2nd week of May was when Europe began to loosen lockdown restrictions. By mid-May investors started to support stocks that were heavily affected by COVID policies but were likely to survive as long as the end of the policies remained highly visible. This includes the Banks and Industrial sectors.
Act 5: 3rd – 4th week June? Equity markets to recover their previous peak? Currently, the MSCI World Index is 6% below the pre-COVID peak.
While we have yet to see how Act 5 develops, or whether there is a surprise Act 6 or 7, we find it incredible that it may be possible that in just 4 short months that the equity markets could have plummeted as well as recovered during a time when we are witnessing some of the worst economic data the world has seen since the Great Depression. Indeed, the Global Credit Index (USD corporate bonds) is already up 2% YTD.
Room Left in Laggard Play
While much of the low hanging fruit was picked last week in terms of the under-performing Banks and Industrials, we believe there is still value in the laggard play. Value has been beating Growth in recent weeks, and while this may be a temporary blip to the 10-year Growth out-performance, participating in trend reversals can add meaningfully to performance.
We note that Banks remain 27% below the S&P 500’s peak on the 19th February, compared to Consumer Discretionary, Information Technology, and Healthcare, the sectors that have already regained their previous peaks. Because we are mid-cycle in the laggard recovery, we expect there to be some volatility, but as the global economy slowly climbs out of lockdown, we expect the laggard plays to continue to play catch-up. In Industrials, travel related stocks such as airlines and cruise ships, surged last week. This is likely to remain a highly volatile sub-sector but and may represent a highly sensitive play to the loosening of lockdown restrictions.
Figure 2: Performance of S&P 500 Sectors Since pre-COVID Peak Source: Bloomberg
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