Central banks continue to prop-up markets

The tsunami of money has been unprecedented and is the main reason equity markets have performed as they have.

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  1. Charles Stanley

The stimulus measures have been at their largest in the US, where money growth has shot up to 25% for the year. In the Eurozone and the UK, it is a lively but more modest 10%. In the US, the accumulation of large money balances within the financial sector has led to substantial investment purchases of financial assets, with institutions buying more shares as the Federal Reserve tempts them to sell some of their bonds to assist the vast quantitative easing purchase programme.

In the last couple of weeks, there has been a marked slowing of the pace of the official purchases on both sides of the Atlantic, as central banks think they have done enough to overwhelm the gloom of markets in late March and to return interest rates and asset values to levels they feel happier with. This implies more of a two-way market from here, with perhaps less indiscriminate buying. It has not yet led to a major sell-off, as many market participants assume the Fed and the others would want to stop any sharp falls as they did in March. There are also probably still portfolio managers with more cash than they feel comfortable with for a rising market.

Some say the market from here will be dictated by the Covid-19 narrative. We ourselves tore up the conventional scenarios for 2020 early in the virus spread and based our outlooks for this year and next on the duration of the lockdowns, the likelihood of the virus retreat and the danger of a second wave. These will be the main factors that affect the outturns for output and profits and will be one of the primary drivers of business and investment news flow for the rest of 2020.

No quick recovery

We can now say with reasonable certainty that our very low probability best case of a quick V-shaped recovery from the lows of April will not happen. The recovery will take longer, will be patchy, and will be driven by substantial remodelling of how businesses work and how consumers spend. If all goes well, we could recover world levels of output by the end of next year, though some areas will be well up on 2019 and others still well down. The worse cases mean it will take longer, with a very bad case being a sufficiently widespread flare-up in the virus in enough of the world economy to warrant a second very damaging general lockdown.

We need to ask ourselves why, if we and many others think a slow recovery with damaged sectors is the most likely, is the market as high as it is? If there are plausible worse cases that mean even more damaged profits and turnover for significant areas, again why is this not discounted in some way by current prices? It seems to come down to the relentless weight of money and the actions of the authorities, who have forced professional investors whose experience and training tells them to be bearish into being bullish, so they do not stay wrong for long. Weight of money and fashion count.

There is a virus narrative to fit to the more bullish outlook of the market in recent weeks. People who are bullish in their heart think we have now seen off the virus in the major economies. They gamble there will be no more national lockdowns, and gradually the social distancing impediments to business will be relaxed.

Others acknowledge that there could be flare-ups in various locations but reckon the authorities have now learned more about how to contain this. Where every major country allowed the virus to gain a strong hold, then clamped everything making most people isolate at home, next time they expect a different approach. With much more testing available, and with some better and more reliable tests, the idea is the authorities will intercept carriers more quickly, and demand the isolation of carriers and contacts, not the whole of society.

Theory vs practice

This would certainly produce a much better economic result. The weakness is it does rely on a high degree of co-operation from individuals, reporting their symptoms and their contacts. Some Asian societies where people are used to governments knowing a lot about them and controlling more of their lives will find this easier to do than western societies with more robust or unruly independence.

We also need to see the growing divergence between the magnitude of the economic response in the US and that in Europe or Japan. The latest IMF forecasts point to Italy, Spain and France all suffering GDP falls in excess of 12% this year, compared to the US at 8%. Only Germany of the European majors does slightly better in the IMF estimates than the US, thanks to its low incidence and or good handling of the virus so far.

Given the structural demands being made on the German industry by net zero carbon, and given the central role in the digital revolution grasped by US corporations, the US may outperform Germany again as well this year.

We need to follow both the virus and the money. So far, the virus has badly damaged general economic activity, but the money has triumphed in financial markets. We need to get used to more expensive valuations of share prices against earnings and dividends for as long as they keep printing those dollars. It is also still wise to avoid investment in sectors and companies particularly damaged by events so far and facing a problematic revival, as it here we should anticipate more trouble ahead as they seek refinancing or move into administration. If a company has to refinance at the expense of shareholders, even a general tidal wave of new dollars does not prevent losses for holders.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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