Optimism abounds, but it’s right to be cautious

Optimism abounds, It is turning into a week of two halves for financial markets. The start of the week was doom and gloom about the end of the road for the tech stock rally, deteriorating relations between China and the West and concerns about a second wave of Coronavirus. However, the second half is turning out to be far brighter. Stock markets across the globe, with the exception of China, are a sea of green on Wednesday, as US earnings data, positive news about a vaccine for Coronavirus and an expected rolling back of oil production cuts from Opec members are all helping to buoy markets. While traders are trigger happy and markets are rising on a broad basis, the smartest guys in the room will be hedging their bets, as capricious markets, particularly in these summer months can come back to bite the evangelists. 

When it comes to vaccines, follow the crowd 

There are plenty of social media trading stars who will tell you that stocks always go higher, and in the long run, the data suggests that this is correct. However, unless you buy and hold stocks for a number of years, then you will probably want to think about tempering your enthusiasm when markets get a little too gleeful. While we believe that news about a potential vaccine is positive for financial markets, the latest reports that pharma company Moderna has said that its vaccine elicited antibodies in all 45 people on its recent trial, should be approached cautiously. This vaccine also elicited side effects, these were severe in three of the recipients. Two things stand out for us: firstly, 45 people (extremely small sample size, trials will have to be much larger before this vaccine can be rolled out globally), and secondly, severe reactions; what is the point of having a vaccine to protect against coronavirus if it makes people sick with fatigue, chills and muscle pain. Of course, antibodies are the holy grail, but this vaccine still has a long way to go. Thus, the initial 18% surge in Moderna’s share price today to a record high, the stock is listed on the Nasdaq, looks overdone. It has since given back some gains, but it is still 8% higher. Astra Zeneca’s share price is also at a record high and is trading 5% higher. The results of its trial with Oxford University are expected on Thursday, if it shows a similar antibody response to Moderna’s along with fewer side effects, then we would expect to see Moderna’s share price fall, with Astra Zeneca’s share price rising even further into record-breaking territory.

AZ vs Moderna 

In the current environment, we are big supporters of the healthcare sector, and pharma companies in particular. We are recovering from the steepest decline in economic output for hundreds of years and there is the potential for a second wave of the virus to put the global economy back into lockdown. With this backdrop, healthcare seems like a fairly safe store of capital. However, we would be wary of rushing into pharma stocks at these elevated levels, or in the aftermath of 18% increases. This is where day traders can get burnt. If you’re tempted to buy Astra Zeneca today ask yourself this question: what if the trial results disappoint the market, or the timetable for an available vaccine is not as aggressive as the market would like? We would much prefer to buy pharma companies on a pullback when traders have digested that a vaccine trial is a multi-stage process and a useful vaccine could still be years’ away. Thus, if Astra Zeneca does underwhelm the market tomorrow, that is when Minerva Analysis will start getting interested in the stock. 

Banks results set markets alight, but for how long? 

The Fed and other major central banks have bought the markets some time for pharma giants to find a vaccine that will help to eliminate coronavirus. However, the reality of the economic costs of the pandemic were brought home by banking results for Q2 in the US. JP Morgan may have beaten analyst expectations for Q2 revenue and profit, but it also set aside $8.9bn for expected loan losses across the firm. JP Morgan’s retail business is suffering from the effects of Covid, and slipped in to a $176mn loss, compared with a $4.2bn profit a year earlier. However, this didn’t matter for Q2, as JP Morgan’s investment bank was the driving force behind the $33bn revenue figure for the quarter, on the back of record trading revenues, which beat expectations of $30.3 bn for the quarter. JP Morgan’s share price surged on the back of these results and is more than 6% higher on the week. However, its share price remains more than 12% lower than its YTD peak in mid-February. Goldman Sachs has also reported strong trading revenues for Q2. The investment bank announced $2.42 bn in profit on Wednesday, nearly double what the market had anticipated. It also reported its strongest trading revenues in more than a decade. The GS share price jumped nearly 1% on the news. 

Why Q3 could be JP Morgan’s quarter to shine 

The banking sector may be fairly neglected during the last four months, as tech stocks have stolen the limelight, but there has been some interesting price action within the sector.  Goldman Sachs’ share price has outperformed JP Morgan’s over the last four months during the global stock market recovery. GS has recouped nearly two thirds of its losses from February, compared with less than 50% for JP Morgan. This is largely due to the decimation on Main Street, with JP Morgan’s larger retail banking unit acting as a drag on its share price. However, could the tide be about to change? Volatility (as measured by the Vix) was at 90 at the peak of the crisis, and is currently below 30, thus, unless we see another prolonged period of elevated volatility between now and September trading revenues, often buoyed by high levels of volatility, could moderate in Q3. This is likely to hit GS shares harder than JP Morgan. Also, JP Morgan’s retail unit should start to recover in Q3 as the US economy starts to open up and lockdowns come to an end; we do appreciate that the stop start nature of the US economic reopening due to flare ups of the virus could impact JPM’s retail banking unit, but we still anticipate profits to beat Q2. Thus, while GS’s share price could experience further upside, we believe that the risk/ reward ratio is stronger for JPM right now, and JPM may start to outperform its investment banking rival. 

Overall, being a sensible contrarian can pay off in these markets. As we head towards August, liquidity could start to fall in global markets as traders take a break. Thus, don’t expect the same themes to persist next week as they have this week. Trading requires us all to be nimble.