Market Insights – June 29

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

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Essentials

The number of COVID-19 cases is on the rise again several weeks after lockdown measures were eased in Europe and the USA. The situation is particularly concerning in some southern US states. However, the number of deaths is still well below the levels reached at the height of the pandemic in March and April, and hospitals aren’t overrun as they were at that time.

Buoyed by the markets’ defensive shift last week, gold neared USD 1,800/ounce. Sentiment has cooled slightly but remains high. We are still taking a constructive approach to gold but don’t recommend increasing exposure at current levels.

In Japan, retail sales dropped 12.3% year on year in May, a slightly smaller decline than in April (–13.9%).  The situation should now gradually improve as the state of emergency was lifted at the end of May and all Japanese citizens and residents received a one-off cash payment of JPY 100,000 (around CHF 900).

Severe recession should pave the way for a new business cycle

The main risk weighing on the global economy and the financial markets is the prospect of a second COVID-19 wave in developed countries. In addition to the hygiene and social-distancing rules that authorities almost everywhere are trying to keep in place, countries’ ability to conduct large-scale testing and contain clusters will be the determining factors until a vaccine is available. The economic fallout from the lockdown has been huge, and the ensuing global recession has been the sharpest ever seen. Governments and central banks around the world took unprecedented measures to limit the damage and ensure a rapid recovery. These policies are now paying off, as seen by the rapid uptick in a good number of economic indicators worldwide. Some business sectors, like tourism and air travel, will feel the effects of the lockdown for some time to come, but the savings people were forced to make during the lockdown are just waiting to be spent. With interest rates at rock bottom and no shortage of cash, economic agents should regain confidence, which should trigger another virtuous cycle of spending and investment. Risk assets have rallied sharply since bottoming out in March, and some stock markets, including those in the USA, are back at their early-year highs. We wouldn’t be surprised to see a period of consolidation at this point. That would help to correct the excessive optimism that is emerging among some categories of investor. However, the climate is ripe for risk assets to continue on their uptrend. Provided the public-health situation doesn’t worsen, equities will offer the most upside over the coming months, especially since the broader bond market still lacks appeal, although riskier segments could gain ground. While the US stock market will probably continue to set the pace over the next few months, some other markets could break loose from the pack. This is the case for eurozone stock markets, which have underperformed for a long time and could now be buoyed by renewed political momentum and the EU’s energy transition fund. We are increasing our exposure to the euro in most of our investment grids, as it could also be lifted by this positive trend. At the same time, we are decreasing our exposure to the US dollar, which, as the global economy picks up, could be weighed down by the USA’s twin deficits and falling yields on the US capital market.

A V-shaped recovery calls for a more selective approach to the US market

In recent months, the US stock market has been like the mountain stage of a cycling race, with a whopping 80% change in altitude. The abrupt 35% decline between mid-February and mid-March marked the end of more than ten years of gains. This was then followed by a rebound that – at more than 40% – was just as steep. Very few investors had expected the recovery to be so fast. However, it is merely a reflection of economic activity, which picked up again at a remarkable speed once countries began easing lockdown measures, each at their own pace. Jobs figures, retail sales and business confidence indexes have all improved in recent weeks. Governments and major central banks have taken concerted action, which has helped to limit the damage and prevent bankruptcies from soaring.

But investors have already largely priced in this potential good news, and valuations now exceed their early-year highs – and their long-run averages – as a result. But these strong multiples, coupled with increasing investor confidence, make the market more vulnerable to bad news. Another spike in coronavirus cases, renewed trade tensions with China or an uncertain US presidential campaign – these are all factors that could keep the markets volatile in the second half. That has prompted us to be more selective and to reduce our sector bias in the short term.

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