Market Insights – May 25, 2020

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

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Lumière du coucher du soleil à Rolle en Suisse.


Germany and France want to create a rescue fund to boost the sectors and regions hit hardest by the pandemic. This is an unprecedented project – up until recently Germany had been firmly opposed to the idea of mutualising EU debt. The proposal still needs to be approved by EU Member States, which won’t be easy.

The Hang Seng Index lost more than 5% on Friday after China announced a new Hong Kong security law that would give Beijing more control over the former British colony. This uncertainty has dampened the outlook for the Hong Kong market, which could nevertheless be boosted by the secondary listings of Chinese companies currently traded in the USA.

Unlike in April, May WTI oil futures expired with no major mishaps. Oil prices even continued to move upwards. In the short to medium term, prices are unlikely to break above USD 35 a barrel, a level that would lead US producers to rapidly ramp up their output.

Liquidity is returning to the bond market

Low liquidity on the fixed-income market has been a recurring problem since the 2008 crisis. In the wake of that crisis, which shook the financial system to its core, the trading activities of major investment banks came under increasingly strict regulations throughout the world. These banks responded by sharply curtailing their proprietary trading activities and reverting to their original business model as an intermediary between buyers and sellers. They still play this central role on the bond market, where most transactions take place over the counter. The systemic risk is now much more closely managed, but the lack of liquidity is an issue, especially during periods of market tension. It can be difficult to sell a position when brokers won’t make a market because they are waiting for bond investors who have become more risk averse to return. This is exactly what happened in March. The lack of liquidity can be felt most on the riskiest segments of the bond market. But to everyone’s surprise, it has affected the safest government bonds at times as well. With few players trading on the market, bid-ask spreads widened to levels not seen since the 2008 crisis. These signs of stress triggered an aggressive response from the major central banks, especially the US Federal Reserve and the European Central Bank. They injected hundreds of billions into their asset purchase programmes, which brought some calm to the capital markets at the height of the COVID-19 crisis. Thanks to the careful timing of these interventions, the bond market held up, and we’re now starting to see end-investors coming back after temporarily fleeing their usual stomping ground. It’s become easier to trade bonds, and yield spreads between lower-quality debt and top-grade bonds have narrowed. We think that bond market liquidity should gradually return to normal over the coming months and that riskier segments, such as high yields and emerging-market debt, will outperform.

Caution after US multiples hit a peak

The Q1 earnings season is coming to an end. When you look at how stock markets have risen in recent weeks, it’s hard to believe that US corporates recorded a more than 13% drop in earnings, the sharpest decline since the 2008 financial crisis.

The evidence suggests that investors have chosen to look beyond the current crisis, which should be short-lived. Catastrophic economic data have been largely ignored in recent trading sessions, as analysts are already trying to quantify the sharp rebound in earnings expected in 2021.

COVID-19 represents a temporary, exogenous shock, so the US economy should bounce back relatively quickly and earnings per share should jump by more than 40% in 2021. But the worst is still to come. Analysts’ forecasts continue to plummet for the second quarter of 2020. At end-March, the consensus was for earnings to drop by 10% in Q2, but the decline is now expected to be more than 40%. Given the lack of visibility, it’s hard to tell what the impact will be on full-year earnings.

The decline in earnings forecasts, combined with the stock-market rally, has triggered a record rise in multiples. The S&P 500 is now trading at a Price to Earnings ratio of more than 21. This leaves little room for disappointment and for further geopolitical tensions, which will certainly take centre stage again as we head into the US election season in the autumn.


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