Global equities are slipping, aside from US tech shares and a relentless rally in China, with risk sentiment finally taking notice of new Covid-19 cases in Hong Kong, Tokyo, Australia, Mexico and the US.
This suggests a global economic recovery being clipped in the coming weeks. In fairness, the market pattern of late has not been fully “risk on” given that investors have favoured secular growth, quality and defensive sectors. Or as some note, technology, gold and at least for now, Chinese shares.
Such herding does heighten the prospect of a sudden and volatile exit trade at some stage. Although very supportive central banks are doing all they can to minimise such an outcome.
Indeed, the US 10-year Treasury note yield is utterly anchored around 0.6 per cent and has been since April, apart from a brief pop towards 0.9 per cent in early June on upbeat economic data. A world of open-ended quantitative easing does cap long-dated yields, but the recent decline in the 10-year nominal yield has been accompanied by the US economic surprise index setting an all-time high.
Such a divergence between Treasury yields and data raises eyebrows in some quarters and Albert Edwards at Société Générale notes:
“If bond yields can’t rise on strong data, it beggars the question as to what will happen when the economic surprise indicator begins to turn down again — as it will surely do. We reaffirm our view that US bond yields will soon be negative along the whole length of the curve.”
Slumbering long-dated yields are not just a worrying signal about future growth expectations, they also knock the revenues of financials.
And one area to watch over the coming week is that of financials as companies in the sector release their latest quarterly earnings and guidance. True, tech dominates the S&P 500 like never before, and investors appear very confident that the sector is a true beneficiary of pandemic shutdowns.
But financials remain an important barometer of conditions in the real economy. Now a truly awful earnings quarter is expected, and that of course means there is scope for the usual upside surprise that spurs a bump in share prices.
Looking at the recent performance of global and US financials reveals a market preparing for the worst and hoping for a pleasant surprise. Over the past month tech shares have rallied in the region of 6 per cent, while MSCI All World financials are down 8 per cent and S&P 500 financials are off 11 per cent. On the year, global tech has gained some 18 per cent, whereas financials are off by nearly a quarter.
Next week, the focus on results from US banks and their assessment of troubled loans should guide near-term sentiment. One note of caution is that the S&P index of US regional banks has fallen 22 per cent in the past month for a loss of 40 per cent in 2020. The index currently remains a quarter above its March low, but the guidance from the banks sitting at the coalface of the broader US economy looms as being pivotal.
Sustaining the stock market bounce from here requires upbeat news from smaller and medium-sized lenders. A signal of tougher credit conditions for smaller businesses does have scope for spurring a more volatile trading summer in markets. Some, however, argue that such thinking ignores an important shift.
Steve Ricchiuto at Mizuho Securities argues that co-ordinated fiscal and monetary policy stimulus is “a policy prescription most working economists and/or strategists have only read about and never witnessed in person”.
Steve thinks while many are focused on the recessionary consequences and the hit on corporate earnings from Covid-19, the revival of a Keynesian policy approach is designed to avoid deflation while stimulating the recovery.
“The one clear result has been asset inflation and it is evident in every market where policymakers are active, especially here.”
As for banks, the support of central banks suggests loan losses may well be contained, but the long-term consequences point towards a protracted recovery, reinforced by a substantial rise in corporate and government debt levels this year. And that’s the really worrying message being sent from deeply negative real yields.
Quick Hits — What’s on the markets radar?
Switching gears, China is certainly looking hotter and frothier. The local share market has risen for the past eight days with the CSI 300 up another 1.4 per cent. A rising tide lifts plenty of boats and the onshore-traded renminbi rose 0.2 per cent on Thursday to Rmb6.9899 per dollar, its best level since March.
Notably, authorities are cracking down on the illegal use of margin financing for shares, but the horse has truly bolted that stable. The FT’s Tom Hale and Wang Xueqiao look at why a five-year peak in margin financing paints a worrying picture.
The latest weekly US jobless claims beat expectations — 1.314m versus a forecast rise of 1.375m — alleviating concerns for now that renewed shutdowns will result in more job losses.
Joshua Shapiro at MFR in New York pours some cold water on the numbers:
“The fact that initial unemployment claims are still running over 1.3m per week this far into the onset of the pandemic in the US, and the stubbornly high level of continuing claims, provides a cautionary message about the difficulties involved and the time it will take to heal a labour market thrown into turmoil by unprecedented circumstances.”
Market Forces will return next week.
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