Rising rates of infections put recovery at risk
Stock markets experienced substantial gains in the second quarter. However, the optimism started to fade in mid-June after a strong start to the month lost steam when rising infections became prevalent in some US states and South American countries.
In the US, the S&P500, which gained 20% during the second quarter, had its best quarter since 1998. But from mid-June, the rally in equities slowed as the reality started to sink in that the economic recovery could take longer than best-cased scenarios of a V-shaped recovery.
Coronavirus infections started climbing in the most populated states in the US, Texas and Florida, while elsewhere, Brazil and Iran also saw worrying increases in rates of infections. Brazilian President Jair Bolsonaro, who has consistently played down the dangers of the virus, tested positive for COVID-19 and is being sued by the press for taking off his mask during the media briefing where he announced he had the virus.
Investors recognize that it may be a longer road ahead than anticipated, marked with continued volatility until the global economic recovery gains traction.
Deteriorating US-China relations also cast a pall over financial markets and economic sentiment. US President Donald Trump continued to strike out against China, accusing it of not being transparent enough about the extent of the danger posed by the coronavirus.
When China announced plans to impose new national security laws on Hong Kong, Trump promised to hit back hard. The move also prompted adverse reactions globally to the change in the one country, two systems framework that has been in place to date. With all the uncertainty and signs that the Chinese government is adopting more active oversight of Hong Kong, foreigners and businesses are likely to look to relocate to friendlier regions.
Emerging markets, most vulnerable to any shift in globalization prospects because they rely more heavily on trade and healthy commodity prices, look set to be hardest hit by fears of a potential US-China Cold War.
Trump’s divisive stance hasn’t been reserved for China alone. In the lead up to November elections, he has also been fostering distrust and division among the American people, resorting to a playbook of fostering racial unrest and voter suppression.
He has adopted a heavy-handed approach to protests that broke out after the death of George Floyd at the hands of the police, threatening martial law and using racist language against protesters. Recently Trump tweeted that New York City’s decision to paint “Black Lives Matter” on Fifth Avenue was a “symbol of hate.”
Trump is generally perceived as having mishandled the Black Lives Matter movement, a cause that most American voters support for its stance against police brutality and racial injustice.
Stock markets run ahead of economic fortunes
There is a debate about whether stock markets have rallied too far, too fast, given the uncertainty that lies ahead for the global economy. A second wave of infections is still viewed as possible in those countries that have managed to get the first wave under control. But it is generally agreed that it would be a political and economic disaster to completely lock down their economies again.
Many states in the US have had to take a more gradual approach to opening their economies in the face of rising infections as they began opening up in April. With the pandemic seemingly nowhere near to being brought fully under control, behavioural changes are becoming more entrenched, with consumers holding back on spending and many people reluctant to visit malls and hesitant to go to the movies or big events. There has also been a shift in workers’ attitudes, with many not eager to go back to the office and work long hours.
The latest US employment numbers exceeded expectations in June, with payrolls rising 4.8 million and the unemployment rate coming down sharply to 11.1%. But there is still a concern that 31.5 million people are claiming unemployment benefits, and economists warn that the rising rates of infection may adversely impact the job numbers during the months ahead.
From a jobless recovery to a recession
The current recession is unfolding against the backdrop of an American economy that never really exited the last downturn, at least from the standpoint of those who did not participate in the longest bull market in modern history. The so-called recovery from the previous recession proved to be a jobless recovery, during which technology displaced workers as companies sought more efficiency and productivity.
Thus COVID-19 has brought America to the edge of an economic precipice, with employment still 15 million lower than in February and the sharp bounce back in economic growth expected a few months ago unlikely to happen if infection rates are not brought under control soon. The easy part may be behind us as far as job creation goes, and it may be more challenging from here on in to increase the number of people employed in both the US and Canada.
While the world’s largest economy may not face slow suffocation as it did in the Great Depression, with 10 years of weak economic activity, the return to pre-COVID levels may take a couple of years.
Fortunately, banks are in better shape than they were in the Great Depression. With the retraction of the Volker Rule, which was imposed on bank proprietary trading activities after the 2008 financial crisis, the big banks will again have the freedom to make substantial investments into certain assets.
But banks aren’t out of the woods yet, with bank stocks reacting negatively to the news that the Federal Reserve would prevent banks from buying back their shares. The central bank also curtailed the payment of dividends until after the stress tests are conducted later this year. It took these decisions based on evidence that the COVID-19 crisis could result in loan losses of some $700 billion, which they believe could see some lenders come close to their capital minimums. These provisions are likely to be extended quarter by quarter until economic conditions improve.
The Federal Reserve is still highly active in providing liquidity to the credit markets, buying US$428-million in bonds of various companies during June. They also purchased more than $5 billion worth of 16 corporate bond exchange-traded funds (ETFs), including one high yield corporate bond ETF. The central bank’s shopping spree is intended to keep corporate borrowing costs low and maintain the flow of credit after the March panic saw markets sell-off and liquidity dry up. The Fed also hopes to see its efforts result in fewer layoffs.
Europe debates the practicalities of fiscal stimulus
The European Union, which has mostly brought the COVID-19 infections under control, still recognizes the economic challenges that lie ahead and is negotiating a 750 billion euros ($841 billion) fiscal stimulus package to boost the economies hardest hit by the virus.
However, negotiations are proving challenging, with the 27 European governments trying to bridge the divisions among EU countries over how much they should borrow from capital markets, how the money should be distributed and what form the fiscal support should take.
The Canadian economy, which has come under considerable pressure as a result of the pandemic, was dealt another blow when Fitch ratings downgraded its sovereign credit rating from AAA to AA+. It is the first top-rated country to be downgraded by the rating agency during the pandemic. Fitch cited the state of government finances as the reason for the downgrade. Finance Minister Bill Morneau recently forecast that the government deficit is likely to reach 16% of GDP when the full costs to the government of the COVID-19 crisis are included.
Crude oil rallies on tentative pick-up in demand
Oil prices managed to regain lost ground during the second quarter, increasing from a low of $16 a barrel to above $40 a barrel as demand for energy picked up until the end of May. Supply cutbacks also played its part, with countries holding to the OPEC agreement to sharply curtail production, prompting OPEC oil production to fall to its lower level since 1991.
However, the pace of the recovery in oil prices slowed during June in the face of the rising rates of infections and concerns about the likely pace of the economic recovery. At the end of the first week of July, crude oil prices did respond positively to the better than expected jobs data, with oil prices gaining almost 5%. Still, the future trajectory of the oil industry will depend on demand and OPEC’s decision whether to extend its production cutbacks into August. OPEC is next scheduled to meet in mid-July.
Meanwhile, gold has benefited from its safe-haven status, with the precious metal’s price reaching $1 800 an ounce, an eight-year high, on the rising number of infections in the US and other parts of the world. Silver prices, in contrast, gained no benefit from the risk-off sentiment that set in during June and traded below $18 an ounce during the month.
June may have been an eventful month, beginning on a generally positive note as investors looked to a second-half global economic recovery but then ending on the realization that a rebound may be pushed out by the resurgence in coronavirus infections. As always, however, we take a long-term view and continue to invest in quality companies amid the challenging political, social, and economic landscape.
Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm with a dedicated team of investment professionals that manage investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 20 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at firstname.lastname@example.org