Where next for markets?
By Peter Westaway, chief economist and head of investment strategy, Vanguard Europe.
Life can come at you fast. One day you’re writing about how rising stock markets may have got ahead of themselves, the next you’re surveying the damage after the pandemic fears you worried might resurface and hit market sentiment do so before you’ve had a chance to publish your blog.
It’s a timely reminder of why investors shouldn’t try to time the market, because it’s very hard to do successfully. It can also lead to costly mistakes, which is why our message is always: be strategic, invest according to your goals, and stay invested through the ups and downs so the positive fundamentals of the market can assert themselves over time.
Given the way some investment markets had been behaving up until late this week, you could have been forgiven for thinking that the Covid-19 crisis was over.
With shares on Wall Street back in bull-market territory, it was hard to avoid the idea that the market’s low point had long been and gone. With the aid of a buoyant technology sector, the S&P 500 index had even climbed to within sight of its pre-pandemic highs, briefly turning positive again for 2020.
That increased optimism was also reflected in fixed-income markets, with 10-year US Treasury yields heading back towards 1% and global high-yield bonds, another signal of risk appetite, retracing most of their losses too.
But then came Thursday’s brutal pullback to remind investors that the market’s capacity to throw up ugly surprises should never be underestimated – and less so when there’s a global virus that has accounted for more than 400,000 deaths so far and led to unprecedented drops in economic output.
Data about economic activity is consistent with this gloomy picture, so we’ve just learned that Britain's economy shrank by a record 20.4% month-in-month in April, the first full month of lockdown. It broadly confirms what we had been predicting for some time.
So should we expect further falls in the market or is this a small bump on the road to full recovery? And can UK and euro-area shares – which are still around 20% below their pre-Covid levels – close the gap on their US counterparts?
On the positive side, the world’s central banks are working overtime to support markets and business and consumer expectations as much as possible. In the euro area alone we’ve now seen confirmation of the €750 billion EU Recovery Fund, providing grants and loans to the hardest-hit countries, and extra support of €130 billion in Germany. This is in addition to the European Central Bank’s decision to extend its Pandemic Emergency programme of quantitative easing by a further €600 billion.
There has been some promising hard data also. In China, some industrial sectors are not only recovering but even clawing back lost orders. And in the US we saw an unexpectedly positive May jobs report.
For all that, the services sector in China remains subdued. The unexpected jump in US non-farm payrolls also ought to be taken with a pinch of salt because of the way furloughed workers are treated in the statistics and because many workers are classed as not looking for work and hence not unemployed.
Here in Europe, meanwhile, we’re seeing lockdown stringency measures being increasingly relaxed, which brings with it the possibility of economic recovery here too. There’s a catch though – a rather large one – because it also brings with it the potential for secondary outbreaks of Covid-19. As I’ve written before, countries face some serious trade-offs.
Recent mass gatherings, whether at protests or on beaches, add to the risks, especially in countries where the situation is less under control. The UK, as the chart below shows, is a case in point; compared with France, German and Italy it is lifting lockdown noticeably earlier.
UK easing out of lockdown at higher daily infections than other countries
Daily new cases (7-day rolling average)
Source: Vanguard calculations based on data from Johns Hopkins University data, sourced from Bloomberg. Data as of 9 June 2020.
With new Covid19 cases still running at a high level, and the test-track-trace procedures still not fully up and running, the danger is that the successful ability of some countries to suppress further outbreaks of the virus (as in South Korea, Australia and Germany, for example) will not be possible in the UK.
If this is the case, there is a risk that the relaxation of lockdown measures might need to be reversed, and the faltering recovery in economic activity might be thrown off course.
In general, we think that the risk of a second Covid-19 wave has risen in recent weeks, although we’re making no adjustments to our economic forecasts for the time being. It’s a risk that applies to other European countries too, not just the UK, and also the United States.
And with Covid-19 still coursing through many developing economies, and in the absence of restrictive cross-country travel restrictions, there is a possibility of a second wave affecting developed market economies more broadly.
Fingers crossed that doesn’t happen but we caution investors against dismissing the possibility as it is something that would send markets tumbling again.
But then that’s the point: even a doctor in economics like me can’t see into the future.
It’s why as an investor you should always expect the unexpected and have a portfolio that is appropriately diversified, aligned to your goals and fit for your purposes.
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© 2020 Vanguard Investments Switzerland GmbH. All rights reserved.