Market Insights – November 16, 2020

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

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Essentials

Two of Boris Johnson’s key advisors, both of whom were in favour of a hard Brexit, have been forced to step down. This may be a setback for the British prime minister, but it could make the talks with the EU easier and increase the chances of a Brexit agreement being reached before the end of the year. If the pound’s rally is anything to go by, the markets welcomed this news.

US small caps have been particularly popular among investors since March. They’ve made up much of the ground they had lost against blue chips, which had been riding high since early 2019. The prospects of a COVID-19 vaccine soon being available is especially good news for small caps, so we expect them to keep outperforming up to the end of the year.

On Sunday, 15 Asia-Pacific countries signed an agreement to form the world’s largest trading bloc, covering a third of the world’s population and 30% of global GDP. The Regional Comprehensive Economic Partnership (RCEP) aims to eliminate 90% of import tariffs within the bloc and is China’s response to the Trans-Pacific Partnership (TPP), which was created by the US and didn’t include China.

Looking beyond the short term

Inflation is still very low in most developed countries. Economies came to a standstill in the wake of the COVID-19 pandemic, triggering another phase of disinflation that is still ongoing as we near the end of the year. Consumer prices, for instance, have remained almost flat in the past year in the eurozone and have risen just over 1% in the States. These levels mean that central banks still have plenty of room to keep supporting the economy. In fact, the central bankers’ toolbox is not as empty as some like to think. The European Central Bank and the US Federal Reserve have made no secret of the fact that they will bring in more stimulus packages if needed. With both Europe and North America in the midst of a second wave of the pandemic, central banks are likely to expand their asset purchase programmes at their upcoming meetings in mid-December, injecting massive amounts of liquidity into their economies. This should prevent the economies from stalling too much as a result of the new lockdowns in Europe and a potential lockdown in the States. They just need to keep things ticking over until one or more vaccines become available in the first half of next year – that’s the only thing that will restore the global economy’s long-term trend. Since Pfizer announced that its vaccine was highly effective ¬– and Moderna did the same on Monday – the financial markets have been focusing more on the brightening long-term outlook and less on the current public-health situation, which looks set to remain difficult for several months to come. Stock markets made gains over the week. 

Wall Street and some Asian markets are nearing new record highs. So it’s better to shift attention to the new phase of the business cycle that we’re about to enter and that should result in a sharp rebound in corporate earnings growth over the next two years. These positive developments – combined with the decline in political risks linked to the US presidential election – lead us to believe that things are looking good for equities and other risk assets as we head towards the end of the year. As a reminder, a week ago we increased our equity allocation in portfolios, with a preference for the economic regions and business sectors that will be buoyed most by the upcoming release of the COVID-19 vaccine (or vaccines) and the renewed uptick in global economic growth.

Japan – an old-fashioned recipe

Japan has been experiencing a third wave of coronavirus infections in recent weeks, after the previous peak was reached in early August. It’s hard to say how bad this winter wave will be or whether the public-health crisis is already coming to an end. Regardless, the most important thing is that the death rate has dropped considerably and the curve is now slowly heading downwards, as is the case elsewhere in the world. In terms of politics, the transition from Abenomics to Suganomics has been fairly seamless so far. The new prime minister, Yoshihide Suga, will continue to work hand in hand with the governor of the Bank of Japan, Haruhiko Kuroda. For the moment, the main things that set Suga apart from his predecessor are his focus on domestic affairs and his plans to speed up the economy’s digital transformation and develop tourism across the country.

Japan’s economic recovery has been similar to that observed in other developed countries. Consumer spending provided the initial boost, buoyed by the sweeping stimulus measures, and then the manufacturing sector also picked up. Consumer spending was one of the main drivers of the 21% rebound in real GDP in the third quarter, although it was not enough to fully make up for the post-war period’s largest-ever economic contraction recorded in the previous quarter.However, valuations are still high relative to global equities and in terms of their long-run average, so we’re not overly bullish on Japanese equities. But there is now talk of a new stimulus package being brought in before the end of the year to boost economic growth in the run-up to the 2021 election. If this happens, we could well take a more constructive stance on this market.

 

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