Market Insights – July 13, 2020

Each week, a team of experts shares its market views with you.

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Essentials

China’s outstanding total social financing, a broad measure of how much the real economy gets from the financial system, continued to rise in June, up 12.8% year on year. This reflects the expansionary policies introduced by Beijing to speed up lending growth in response to the COVID-19 pandemic.

The Q2 earnings season gets under way this week in the USA, and the consensus seems to have overlooked the many signs of recovery that have appeared over the past three months. Earnings forecasts are extremely conservative, and we think there will be positive surprises that will lift the stock markets.

The UK government recently unveiled further stimulus measures, including bonuses for each employee brought back from furlough and VAT rate cuts. This is in addition to the rescue package announced back in March, worth 25% of GDP. Other measures could follow in the autumn, as the UK is one of the European countries hit hardest by COVID-19.

Countries excessive debt levels aren't a problem – for now

The automobile sector has been struggling since the start of the COVID-19 crisis, and carmakers have come up with some inventive ways of getting things moving again. They have, for example, let buyers get their new car now without having to pay anything until 2022. Governments seem to be taking a similar approach to debt at the moment. Sweeping stimulus packages have been brought in around the world in order to limit the economic impact of the lockdown. More money has been pumped into the economy than it was in the wake of the subprime crisis, and this will push up government debt levels over the long term. The bond market doesn’t seem worried about this for now – most of the stimulus has been funded by major central banks through large-scale asset purchases. The US Federal Reserve and the European Central Bank have been the busiest when it comes to monetising sovereign debt. Each month, they spend billions buying back government bonds in order to prevent their ballooning deficits from triggering a rate rise. These plans have so far proved very effective, since sovereign yields are still close to their all-time lows, even in more fragile southern European countries hit hard by the public health crisis. Economists all agree that this unconventional approach to funding deficits isn’t sustainable. Whenever money has been pumped into the economy over the long term in the past, inflation has spiralled out of control to some extent. It’s therefore likely that central banks will put away their less traditional policy tools once the economy is back on track, especially if prices start rising as the process of deglobalisation gradually begins and some production chains are relocated. We can therefore expect interest rates to start edging upwards again. Lower quality bonds, such as corporates and emerging-market debt, will be less sensitive to this pressure and are therefore likely to outperform the highest quality government bonds.

An Olympic recovery for Japan

Even though this summer’s Tokyo Olympics have been cancelled, Japan has kept its competitive edge: its fiscal stimulus package is worth more than 40% of GDP, easily putting Japan in first place on the coronavirus stimulus scoreboard.

The financial-market recovery came surprisingly fast, and nowhere more so than in Japan, where COVID-19 hit the economy very hard. Machine tool orders fell 53% year on year, and consumer confidence is currently lower than it was during the 2008 financial crisis.

Owing to travel restrictions, the number of tourists plummeted 99.9% in May, coming in at just 1,700 for the month, or 55 people per day. These figures represent just a tiny fraction of the close to 3 million tourists who visited the country in July 2019. One of the few sectors to be showing some encouraging signs is the automobile sector: both cyclical and discretionary, it is faring well thanks mainly to the rise in car sales triggered by limited use of public transport.

The recent rally in Japanese stocks can probably be put down mainly to the Bank of Japan’s interventions. Yet amateur endurance athletes know all too well that if you start off too quickly, you might run out of steam before the end of the race. At the current pace, the Japanese market could well do just that, which is why we recommend a cautious, diversified approach in the short term.

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