Markets take a breather
Investors and traders have stepped away from the punch bowl, for now, as European and US stocks have advanced at a more modest rate compared with last week’s record-breaking gains. However, this may be a temporary reprieve as investors wait for a Fed meeting in the middle of the week that is likely to show the world’s most important central bank remains in dovish mode and on high alert for any sign of economic weakness, even with the astounding labour market data from the US last week.
Why risk appetite remains alive and well
Activity on the FTSE 100 so far on Monday suggests that risk sentiment remains strong. The top performers include risk-sensitive companies including Carnival, the cruise operator, airlines and house builders. The biggest fallers include more defensive companies such as Ocado and pharmaceutical companies. Oil company BP is up nearly 2% after announcing 10,000 job cuts across its global businesses. While there are many reasons to question how long this rally in stock markets can last, especially with the future of the economy and the labour market so uncertain, there are powerful drivers pushing the UK’s blue-chip index higher in the short to medium term, they include:
· Government support:the UK’s business secretary has announced that he will launch working groups to help foster an economic recovery in the UK over the next 18 months. Although the details on how this will work are scant, the market is hearing “more money” for businesses that have been affected by Covid-19, which is one reason why travel and leisure companies, some of the hardest hit from this pandemic, are rallying strongly even when the rest of the market is taking a breather. Added to this, the Chancellor is planning to announce a tailored programme of support for some of the UK’s biggest companies that have seen their business disrupted by Covid-19. Beneficiaries of this support may include British Airways, which prior to the pandemic had been a strong business especially when compared to some of its rivals. Investors may chase companies that are likely to receive support from the government higher in the coming weeks, hence why IAG, BA’s parent company, is up nearly 5% today.
· The Fed: the US central bank meets this week, and it is expected to give its updated economic forecasts. This meeting comes at an interesting point for the US economy. After a horrendous April, the US economy has bounced back strongly in May and defied some of the gloomier predictions about the economic damage that Covid-19 could wreak. The labour market managed to create 2.5 million jobs over the month, although there is some concern that the drop in the unemployment rate to 13.3% in May from 14.7% in April, is not entirely accurate. However, overall, the economic backdrop is not as bad as previously expected. Added to this, US stock markets have recovered sharply, the tech-focused Nasdaq index has completely recouped its losses from February to March. This has led to some concern that the Fed’s massive stimulus programmes to protect the US economy from the pandemic may need to be rolled back. We believe that the Fed will take a cautious path in the months ahead. While negative interest rates are likely to be off the table for now, the Fed will not want to withdraw support too early, especially since a second wave of coronavirus remains a threat to future economic growth. Thus, while the Fed may tweak their economic forecasts higher, we expect them to remain committed to their stimulus plans and state that they could do more to protect the US economy if it is warranted. We also believe that they will refrain from talking about withdrawing stimulus, although we expect Fed chair Powell to get asked about this during the press conference. If the Fed sticks to its dovish mantra, even if it upgrades its economic forecasts, then we believe that equity prices around the world could move higher on the back of this meeting.
· AstraZeneca: The biggest company on the FTSE 100 was in the news at the weekend after reports that it had approached US pharma giant Gilead about a potential merger. Apparently, the offer has been rescinded and no such merger will take place, however this still has important significance for market sentiment. If, even in the middle of a pandemic, corporate mergers and deal-making are back on the agenda, then it suggests a return to normality in the business world. This is likely to boost confidence in financial markets and is a significant development even if it didn’t actually take place.
As you can see, for as long as central banks maintain their unprecedented support for the global economy alongside government programmes to support businesses hit by the pandemic, then we can expect risk appetite to remain strong. For now, this means that stocks may push higher, especially riskier companies with cheaper valuations. However, investors are also hedging their bets, and gold is hovering around its recent elevated levels just below the $1,700 mark. Demand for gold remains robust for two reasons: firstly, as a hedge against another economic lockdown and a second wave of coronavirus, and secondly, as a hedge against central banks printing money and the inflation that this could unleash in the future. Here at Minerva, we believe that inflation is a distant threat, however, investors are likely to remain interested in gold just in case inflation comes home to roost sooner than expected.