Market Insights – November 2, 2020

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Essentiels

In October, China’s manufacturing sector grew at its fastest pace since 2011. The Caixin manufacturing PMI rose to 53.6, up from 53 a month earlier and beating economists’ forecast of 52.8. That’s the sixth month in a row that the PMI has stayed in expansion territory, above the 50 mark.

Oil prices are under pressure and have dropped back to their June levels. Prices are being pulled down by fears that demand will drop as a result of the resurgence in COVID-19 cases, as well as by the increase in output in Libya and the potential normalisation in US-Iran relations if Joe Biden becomes president.

US tech and internet stocks bore the brunt of last week’s market correction. Investors took profits on these widely held shares despite their solid earnings figures. Most of these companies have recorded year-to-date performances and valuations above those of the wider market, and prices are likely to keep returning to normal.

Inflation – a never-ending slumber?

It’s been a while since inflation kept central bankers awake at night. In developed countries, inflation has been under control for close to 30 years now. And when it does cause concern it’s usually because it is too sluggish during more turbulent times and central bankers are worried about deflation. At the moment, that’s particularly true in Japan and the eurozone, where the economic impacts of the public health crisis drove inflation down to zero in the spring. And in the States, inflation seems to have stabilised at an annual rate of around 1.5% after plummeting in the spring. That’s why the world’s most powerful central banker, Jerome Powell, the chair of the US Federal Reserve, decided to change the Fed’s monetary policy stance of recent decades and raise the annual inflation target above the sacred 2% level. So there’s no risk of the Fed’s key rate moving back up in the short term, and money will keep getting pumped into the economy. Central banks in the States and elsewhere will therefore keep printing money. But the moment of truth is nevertheless getting nearer. The measures taken in response to the public health crisis will expand the balance sheets of the world’s four largest central banks – the Fed, the ECB, the Bank of Japan and the Bank of England – by close to USD 12 trillion by the end of 2021 – that’s the equivalent of close to 30% of those countries’ GDP. It’s unprecedented. If central banks manage to keep inflation in check for the next five to ten years, it could well mean that the link between the money supply and consumer prices has been broken.

Otherwise there’s always a chance that inflation could spiral out of control. Inflation is the biggest threat to bond investments, as it could cause yields to soar throughout the world. In recent days, US long-term yields have started creeping upwards. Ten-year yields are nearing 0.9%, up from this summer’s all-time low of 0.5%. Inflation-indexed sovereign bonds provide protection against a potential uptick in inflation. Switzerland doesn’t issue this kind of securities, but other countries do. In the States, for instance, they’re known as Treasury Inflation Protected Securities (TIPS).

Short-term risks on eurozone stock markets

COVID-19 cases have risen in recent months, it’s only recently that eurozone stock markets have started to take a turn for the worse. That’s because the second wave is gathering considerable speed. To try and break the momentum, the authorities in countries such as Ireland, France and Germany have brought in much tighter restrictions. Other countries will no doubt follow suit. These new measures will of course weigh on the eurozone economy, just as it was starting to recover from the first wave. This is already reflected in some indicators, like the region’s PMIs. The services PMI is moving further into contraction territory, but the manufacturing sector is holding up well for now, thanks to the global economic recovery led by China.

The region’s second wave is worse than we had expected, which has prompted us to tactically reduce our exposure to eurozone equities in our investment grids. This is while we wait for the situation to calm down and for governments and the European Central Bank to take action. The ECB has clearly signalled that it intends to bring out more ammunition at its next meeting. Finally, the chances of getting a vaccine seem more realistic now, although we don’t know exactly when it will be ready. In time, these developments will help the eurozone economy get back to normal, which, in turn, will help to shore up the markets.

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