Latest European economic and market outlook.
The market continues to wrestle with mounting evidence of a collapse in economic activity and data suggesting that new covid-19 cases are levelling off.
On the one hand, economic data from around the world is alarming. The US economy contracted in the first quarter by its fastest rate since the 2008 financial crisis, with over 30 million jobs lost in the US alone since the pandemic was declared. Elsewhere, the Eurozone Composite PMI recently fell from 29.7 to 13.5, its lowest reading since the data set began in 1995. Although data suggest that China’s economy is beginning to fire up again, a collapse in demand for its exports in the US and Europe may well undermine the strength of such a recovery.
On the other hand, after rising rapidly until mid-April, the number of new covid-19 cases around the world has noticeably levelled off in the past few weeks. There have also been encouraging developments in the search for effective antiviral drugs and a vaccine, most notably the positive effects of Remdesivir and the fact that a potential vaccine developed by the University of Oxford is already being trialled on humans. This adds weight to the argument that we are gradually beating the virus, which in turn is allowing many countries to begin to relax their lockdowns, potentially enabling economic activity to pick up in the coming months.
Another tug of war currently taking place in markets is between a potential collapse in global earnings of up to 50% and the $5.5 trillion of global quantitative easing that has been unleashed so far. Indeed, while earnings are forecast to fall sharply in the short term, they are expected to rebound in 2021, and central bank action to cut interest rates and buy credit has lowered the discount rate, thereby making equity earnings more valuable.
So far the bulls are winning the argument as equity markets have rallied strongly from their lows, with an encouraging bounce in small-caps versus large-caps. However, the sharp rebound leaves little room for downside risks, which continue to loom large. These risks include a surge in infections following the relaxation of social distancing measures, the potential for a second wave of the virus in the winter of 2020/21, and more disturbingly, disappointment in the search for effective medicines and a vaccine. If these risks are realised, the period of lockdown could be extended, and economic costs would spiral even higher. So long as a strong rebound in earnings in 2021 seems plausible, downside risks in the market should be limited, particularly given the unprecedented support from governments and central banks. However, if 2021 earnings become questionable, there could be very substantial downside from current levels.
Given the range of potential outcomes at the current juncture, the portfolio is aiming to avoid taking excessive market directional positioning.
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