The S&P 500 is up 31%

Last week saw a number of significant economic results for Q1 being published. Several major companies released their results as did government agencies publish their GDP figures. The big tech companies such as Microsoft, Google, Facebook and Amazon all recorded record rising profits. This crisis is supporting their cashflow as internet use and online shopping is hitting record levels. Smaller tech is not doing so well such as Uber, Lyft and Airbnb as their service relies on off line delivery.

Some of the US bell weather large capital stocks reported declining revenue. General Electric reported an 8% fall in revenue, while Boeing witnessed a 48% revenue reduction in Q1. Consumer spending has a big impact on US economic growth and this also fell by 7.6%.

The bigger news was the official national GDP figures for the eurozone and USA. The UK figures are not out till next week. USA GDP shrunk by 4.8% while the eurozone fell by 3.8% year on year in Q1. However, these figures only just hint at the falls that are expected to be reported in July for the Q2 results.

Last week another 3.8 million more US citizens filed for unemployment benefits bringing total job losses close to 30 million. The weekly sign on rates are now declining, but to have 30 million laid off in 6 weeks is going to be a massive hit to families and business. US unemployment has gone from 3.7% to 16% in 2 months. The US government has been supporting families with improved job seekers allowances and direct payments to families. Prior to the Coronavirus pandemic we were expecting the US economy to grow by 2% this year.
French GDP figures fell by 5.8%, the highest of the European major economies and the country’s biggest year on year fall since records began. The ECB is expecting the down turn in Q2 to be very much worse. They are predicting Q2 GDP falls of between 5% and 12%. The range will be influenced by the duration of lockdown and the success of exit strategies.

Perhaps the key quarterly figures will be in Q3 when we all hope to be out of lockdown and economically active again. There are two factor that could have a big influence upon Q3 results. The success of the lockdown exit strategy particularly the extent of social distancing measures and consumer confidence and a breakthrough in anti-virus vaccine and the containment of contagion. The global economy should be recovering and, in the UK, we will know how many of the likely 5 million furloughed workers go back to work or sign on for unemployment benefits.

Business leaders have been urging the Chancellor Rishi Sunak to extend the period and range of furloughing support. Employers are asking for the furloughing scheme to be flexible enough to support a part time route back to full employment in order to prevent mass lay-offs in the summer. So far 66% of UK firms have applied for support through the HMRC furloughing scheme.

The Office of Budget Responsibility (OBR) has now revised its estimate of the cost to the UK taxpayer of the economic measures taken to fight Coronavirus, support the NHS and underpin the economy. This new figure is up 5% and now stands at £104 billion. This is 5% of UK GDP. The government has raised this money through an overdraft with the Bank of England and monthly gilt auctions of £60bn.

Economist are warning that the UK deficit could rise to its highest peacetime value of £260 billion. The budget deficit is the annual amount the government has to borrow to meet the shortfall between current receipts (tax) and government spending. National debt is the total amount the government owes accumulated over many years. This annual gap between what government spends including debt repayment and what it receives in revenue is going to be expensive for a generation or more.

We have been encouraged by the extent of market stability in credit markets that the Federal Reserve is offering. The Fed has allocated US$850bn to buy up all forms of credit including, credit card debt, car loans, student debt and commercial mortgages in order to stem bankruptcies. It is their broad and assured interventions that has underpinned confidence in credit markets and hence equity markets during these exceptionally difficult times. The Federal has also reassured markets that the lower band for interest rates would remain at zero until the economy was back “on track”.

The Federal Reserve helped support the high yield market earlier this month by allowing its asset purchase programme to buy the bonds of so called ‘fallen angels’. Fallen angels are bonds that were recently trading as investment grade but have subsequently been downgraded to the high yield sector. This has created an easing of concerns over the liquidity available in the high yield market to absorb fallen angels with significant amounts of debt. Our portfolios have benefited from this.

In Europe, the ECB has further increased its actions to shelter the eurozone economy as much as it can. The ECB is now lending to eurozone banks at a rate of -1% as long as that money is provided as lending to households and business. The European Banks are therefore now getting paid 1% to lend by the ECB. However, the ECB did not follow the path of the Fed in its asset purchase policy to include high yield credit. Should the ECB decide to extend the scope of its buying to fallen angels this will provide further support to the European high yield market. This would be a positive for risk in general. The ECB will be cautious of doing European governments’ jobs for them given Christine Lagarde has been very clear that government need to step up with their own fiscal stimulus.

There is ongoing doubt as to whether we will see a large-scale EU wide Recovery Fund providing non-repayable grants to member states. If we don’t see coordinated fiscal burden sharing across the EU then individual countries will need to drive their own economic recovery. This is easier said than done for cash strapped countries such as Italy that will need to expand their budget deficits and finance this with bonds. As there is little appetite from investors to absorb a sizeable quantity of new Italian debt in the current environment then the ECB will need to pick up large quantities of debt in the primary market. We will need to see the ECB’s bond buying programmes increased sizably if it is to have the fire power required to buy all of the country sovereign debt that would be needed to enable a rapid recovery from Coronavirus.

The ECB does not wish to be the financial underwriter of insolvent countries or to buy sub-investment grade bonds. This policy mis-match with the Fed has concerned markets about the extent of support available in Europe and this is playing out in stock market returns.

All eyes will be on next Tuesday’s announcements from the German Federal Constitutional Courts. The long-awaited ruling on the legality of past ECB bond purchases will be announced. This is a very sensitive issue as so far, the ECB has bought up a vast amount of Italian debt in order to stabilise Italy, but in doing so, it is accused of going over its limits.

You may have noticed that in April, US equities have had their strongest month since 1987, that said the market ended the month with a two day fall off. A key factor driving this dip was the publication of GDP figures, tensions with China over the source of the Coronavirus and the big elephant in the room which is the sovereign cost of coronavirus.

The analysis from JP Morgan, that markets found their floor on 23rd March is reassuring. The stock market recovery so far is looking better in terms of a rebound than both the 1987 and 2008 crisis. The Vix volatility index is in decline and P/e ratios are returning to pre-crisis levels. Amazingly with all the dire economic news being reported, leading stock markets have recovered in excess of 20% since 23rd March to the end of April. The S&P 500 is up 31%, The FTSE 100 is up 22% and The Eurostoxx 50 index is up 20.5%. The FTSE 100 broke through the 6000 level, hitting 6115 having fallen to 4993.

Given the huge relative outperformance of US stocks in April, it is worth noting the difference between the recovery in the US and that in Europe. A full 10% outperformance may seem stark but given the relatively robust earnings of some of the more software focused names in US Technology as well as the joined up fiscal and monetary response from the United States, it’s clear there is a justification for Europe lagging.

Investors may wonder why such a V-shape stock market recovery has occurred so quickly when so much of the global economic hardship is still to occur. Did markets massively over react? is a self-imposed recession any different from a non-prompted one? We still do not know when or how Covid-19 will be under control or whether we will suffer a second wave and further lockdown.

The average gains for a bear market are 18% so a 31% recovery in the S&P 500 is remarkable given the news output. However, markets have risen from a significant loss but are still heavily down on the market prices of mid-February. The S&P 500 is still -19% off, the FTSE 100 -30% off and the Eurostoxx 50 is -31% off. Given this perspective, while markets have given back significant value, we are still a long way off full recovery and that is likely to be a slower path.

We have for several years held an overweight in US stock and it is this positioning that has aided our own portfolios recovery. We also have zero direct exposure to Europe.

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