Q3: can it possibly deliver?
Major global stock indices have greeted the new quarter in nonchalant fashion, stock indices are up slightly across the US and in the UK, with small declines for parts of Europe, while Asian indices brushed off protests in Hong Kong and had a decent start to July. But as we move into the second half of the year, it’s important to take stock and consider what the major trends are that could move markets in the coming 3-6 months. Will coronavirus still be the dominant theme? Will relations between China and the rest of the world deteriorate further? Can the Nasdaq continue its uphill march? Below we take a look at the major themes that are likely to drive markets in the coming weeks and months.
1, Coronavirus – the hunt for a vaccine
This is likely to be front and centre for traders as we get closer to the winter months and fears about a second wave of the virus combined with flu season start to mount. However, there was some good news on the vaccine front on Wednesday. A vaccine created by German pharma company BioNTech has yielded positive results in a trial conducted with US pharma giant Pfizer. But, don’t get too excited. The sample size was tiny, a mere 24 people received the vaccine and produced antibodies that were significantly higher than the antibodies produced by recovered coronavirus patients. This tells us two things: 1, the trials of this potential vaccine are at the very early stages and vials of a coronavirus vaccine may take months and years to reach our GP surgeries and pharmacies. 2, the fact that our bodies are not making enough antibodies to coronavirus is a sign that herd immunity, as a policy that is now being enacted around the world as lockdowns come to an end, is not going to work. We need a vaccine. It’s good news that the brightest in the pharma industry are working tirelessly to try and find one, but we doubt that we will get a working vaccine before the end of this year. Without that vaccine, uncertainty triggered by the virus will hang like the sword of Damocles over financial markets. This doesn’t mean that markets won’t rally, as we have seen in the last quarter they absolutely can rally, and rally very strongly, but it won’t be in a straight line.
2, Economic data watch
The next three months will show us what kind of economic recovery we will have as global economies emerge from lockdowns. May’s economic data was better than expected, US jobs reports and global PMI reports all beat expectations. More recently, the Bank of England’s chief economist has said that, so far, the UK’s economic recovery has been a V-shape, and he expects that to continue. The flurry of June data has already started to arrive: Chinese manufacturing sentiment was better than expected, so to was the US Manufacturing ISM report for June, which rose to 52.6, beating the 49.5 that was expected. New orders, a key forward indicator, rose to a stunning 56.4, which bodes well for the future of US manufacturing. That said, Germany created half the amount of jobs that had been expected for June, and the US ADP employment report for the private sector, was also weaker than expected, rising by 2.36 million, when the market had been expecting an increase of 3mn jobs. While manufacturing has bounced back, the service sector is more at risk from localised lockdowns as further outbreaks of Covid-19 are detected. While June’s data may be ok, July’s data could reflect weakness on the back of lockdowns as far apart as Texas and Leicester. In the short term, to continue to rally, the markets will be looking for a decent US jobs report this Thursday, it’s released early due to the July 4th holiday, and decent service sector PMI’s for June. Going forward, anything other than V-shaped recoveries could be greeted with a wave of selling of risky assets by investors.
3, Brexit
The deadline to extend the UK’s negotiation period to agree a trade deal with the EU has passed and not much progress has been made, if you believe the press reports. Of course, neither side can be expected to show their hand at this stage, and at this critical time for the global economy we believe that both sides will want to come to as amicable an agreement as possible, with the least amount of disruption to financial markets and economic growth. However, in public both sides need to pander to their home audiences: in Europe that includes those who want to protect the EU, in the UK those being pandered to seem to be solely Boris Johnson’s Brexity base, without a thought for the huge numbers of us that didn’t vote for Brexit in the first place.
However, now comes my contentious view, Boris Johnson is not that into Brexit. He obviously gets on with many of the European leaders, and probably will make concessions to ensure that the City will get access to European markets and customer bases come January 1st 2020. The government won’t want to hollow out the UK’s status as a major financial hub, especially as it needs all of the tax take it can get in the coming years. This is an important driver to get the deal done. Also, with China showing the full force of its might in its dealings with Hong Kong, and the UK clearly taking the side of Hong Kong, we can’t rely on Chinese business to fuel the City of London’s growth in the coming years. Thus, we may get tough talk in the coming months, but we don’t think that this will be followed up by extreme action. At this stage I would bet that the City will, mostly, retain access to European markets, and that will be good news for the pound, which could rally back towards $1.30 versus the US dollar during this quarter.
4, Bargain hunting
US equities had their best ever quarter in Q2, as markets recovered swiftly from the coronavirus sell off in February and March. However, something interesting happened in June: European stock indices started to outperform their US counterparts. Even more interesting is that Europe doesn’t have the same tech-heavy indices that are present in the US. Thus, with the boost to manufacturing data in recent months and some restructurings that could put manufacturing firms on a better footing to weather the economic recovery ahead, we could see the second wave of stock market recovery take place in Europe and in the manufacturing sector. This could mean more Airbus and less Facebook in the coming months. It could also bode well for the3 FTSE 100, which has lagged behind other European indices. The continued healthy recovery in the oil price should help the FTSE 100 to play catch up in the coming quarter, especially if our view on the UK’s post Brexit trade deal with the EU turns out to be correct.
5, The future of social media as stock market star
Tech darlings could also fall out of fashion in the coming months. Facebook’s share price fell nearly 10% last week as the company became engulfed in a crisis over its refusal to censure offensive content. Facebook’s share price is nearly 2% higher today, possibly because the market has realised that mega brands who have ditched Facebook on the back of the offensive content issue, are not its main source of advertising income, and instead small and medium sized businesses are, and these businesses are likely to stick with Facebook because of its enormous reach. However, there is growing momentum that the social media industry will need to work harder to limit offensive content on its sites. Twitter has led the way with this, however, its moral stance hasn’t done much for its share price, which remains well below its June high, and well below its rivals who managed to reach record highs last quarter (including Facebook). Overall, more regulation, which is likely to come, means a hit to profits and weaker share prices, in our view. Thus, social media companies and tech unicorns could struggle in the coming quarter.
There are other themes that will dominate over the coming months, but we think that these are the main ones. You may wonder why we left out the US Presidential election that takes place in November, especially since President Trump is considered toxic due to his handling of the coronavirus crisis and also the Black Lives Matter movement. However, we would argue that US stocks have weathered these storms extremely well and tend to be fairly neutral when it comes to domestic politics, we doubt that this will change in the coming quarter as we lead up to Q4’s election.