Three key questions all traders should be asking right now
As the world starts to emerge from lockdown, now is a good time to contemplate what the “new normal” for financial markets looks like, and whether the recovery in equities in recent weeks has been premature. On top of the pandemic, the world also needs to adjust to an emboldened China, deteriorating US-China relations and a shift in the key players in global stock markets that could last a lifetime.
To help you navigate these tricky waters, we have picked three important questions that we believe should be analysed by anyone trading financial markets right now.
1, Does a record amount of government debt hurt equity trading?
The answer to this all depends on how you trade. If you trade in a short term time frame, then the record amount of borrowing from governments in the US, Europe and in the UK, shouldn‘t have too much impact, although markets may oscillate slightly around the time that government debt figures are released. If you trade on a longer time frame, then government debt is something that you need to consider. An eternal optimist may think that government borrowing during a time of national crisis is a necessity and should be seen as lifeblood, and not a mortal threat to economic stability. For example, if the government had not pledged to help businesses and pay for furloughed employees throughout the current lockdown then there wouldn’t be much of an economy left when the pandemic passes. Added to this, in the UK the government is borrowing money that is funded by the Bank of England, whose mandate is to maintain inflation and economic stability. This is all linked to employment levels, thus, it makes sense for the Bank of England to boost Gilt issuance (which funds borrowing), in fact it becomes important to do so to meet its inflation target, especially after the latest inflation data showed that price growth had fallen to 0.8%.
With UK interest rates at their lowest ever level, and with the BOE contemplating negative interest rates, there has never been a cheaper time to borrow.
For those who are more risk averse, then the repercussions of borrowing at unprecedented rates might be giving them nightmares. The main risks of unfettered government spending are:
· A dysfunctional government who loses the trust of people who fund their debt by either spending frivolously or through bad political decisions. This could lead to a debt crisis and a rapid rise in interest rates.
· High debt levels, an aging population and weak growth could mean low inflation or deflation for a prolonged period, zombie companies and low growth, including low equity market returns. A counter to this is that the UK population is not that old compared to other nations, thus there is scope to grow our way out of this crisis.
While we can’t rule out the first risk entirely, even if you dislike this government, we assume that they will not do anything that will question the capability of the UK to pay back its debts. The second point is also a risk, even though future policy that focuses on growth rather than austerity and supports both large and small enterprise should help the UK from falling into the same trap as Japan did in the 1990s.
Overall, we don’t think that record high borrowing will hurt the UK economy in the long term. From the perspective of the FTSE 350, an economy that was kept alive during exceptional circumstances by emergency government spending is better than having an economy left in tatters from the pandemic. In the coming months, retail sales in the UK could recover sharply, partly due to the government’s furlough scheme, so all of the government borrowing could pay off sooner than we think.
2, China
China shocked the world when it said it was imposing a new security law on Hong Kong that would bypass Hong Kong’s own judicial system. This has stoked fears that China will use the pandemic to boost its political power and show its might as a global super-power. While that point is better left to international relations experts, we believe that this exertion of power is primarily negative for localised markets, the Hang Seng in particular. We don’t think that there is any evidence that China will try to show its might further afield than Hong Kong. We have an optimistic view on Asia, and Asian economies could do well in the coming months as they have emerged from lockdown before the majority of western countries, which could be reflected in stronger Asian stock market performance, especially compared to Europe, in the coming months.
However, that does not mean that this development is neutral for risk. If the latest move by Beijing causes a deterioration in relations with the US, or stokes concerns about a trade war 2.0, then we would expect global financial markets to be impacted, and for Asian markets to tumble. The prospect of another year of tense trading relations between the US and China is not what the world needs as it tries to rebuild growth after the coronavirus.
3, A changing of the guard for equity markets
This point is becoming extremely relevant. If this global pandemic is an epoch-changing moment for the global economy, then there have already been some notable winners and losers. If we look at the US, nearly 70% of the US economy is driven by personal consumption. Thus, it is worth noting changes in US spending habits during this extraordinary period as they may herald some themes and trends to watch in the future.
Based on US consumption data for March and April the big winners are groceries, grocery deliveries, and food take out. The biggest losers include clothing sales, restaurant sales and all forms of travel, especially cruise liners. Interestingly, sales at pharmacies also fell sharply during the March – April period as people stayed away from doctors’ appointments and hospital visits. This is bad news for the likes of CVS and Walgreens, the largest pharmacies that are listed in the US. We would expect profits at these two companies to be badly impacted in Q2, although they could bounce back in Q3 as people return to their pre-pandemic healthcare routines.
These changes in US consumption trends have already impacted retail brands and could leave a lasting impact. Some of the retailers that have seen their brand value surge during this pandemic include: Lululemon – largely due to its large online presence and focus on loungewear and athleisure, Walmart – as a one stop shop, Target – due to its heavy investment in technology and growth of its click and collect service; Amazon is another big winner due to the surge in online shopping and at-home entertainment. Online retailers in China and India, the world’s most populous countries, are also worth watching. Alibaba in China and India’s Flipkart, owned by Walmart, could see their stock value continue to rise after the pandemic is over.
On the other side of the coin, companies that rely on consumer footfall and have not kept up with investment in their online businesses are also worth watching. M&S in the UK, Uniqlo and Under Armour are companies that could struggle. H&M is also struggling, although that is largely due to the intense competition in the cheap apparel market and perceived quality levels. Burberry in the UK has seen sales slump due to the major decline in designer goods sales, although we believe that the lifting of lockdowns across Asia could help to rebuild sales in the coming months. Subway, the sandwich chain, is also likely to suffer some permanent damage due to its huge number of global bricks and mortar outlets.
Overall, this crisis may be the death knell for some brands that were already considered weak. If you were thinking of trading the retail sector for the longer term, then it may be worth ditching some of the old guard like M&S, H&M or any of the major fast food outlets. Instead, retail brands that are likely to continue to thrive after the lockdown will need to have the following attributes: value for money, having a unique selling point or standing for something that consumers find meaningful, along with being a premium brand. The final point is worth noting; we believe that premium brands will continue to thrive as consumers, who may have straightened budgets, look for branded produce that is perceived to be worth more than what you pay for it. Lululemon fits these criteria, in our view.
To conclude, as the pace of the global equity market recovery looks like it may have stalled, there are some big questions and themes that traders and investors need to consider before they make their next move. We hope that this note has been useful and given you some clarity in these confusing times.