Beginning of the end for equities?

The recovery in equity markets stalled in September – so is the great comeback since March over? Danske Bank’s strategy team takes stock of equity markets going into the final quarter of the year, which will also see the US presidential election.

Equities have made a fantastic comeback since prices plunged in the spring, but the party seemed to stall in September. Global equity prices experienced significant volatility and a small decline, while a number of risks are intruding. The coronavirus has flared up again in Europe, and US politicians have so far failed to agree a new fiscal relief package. Further uncertainties only add to the pressure, including the unresolved Brexit situation and the presidential election in the US, where Donald Trump has contracted COVID-19.

Are rising equity prices over for now?

“That depends on your investment horizon. The next few months could very well see more uncertainty and volatility, but looking a little further ahead we see a potential for additional increases in equity prices. We essentially expect the gradual normalisation of the global economy to continue, which should lift equities further, in our view. We are therefore maintaining a modest overweight in equities in our portfolios and an equivalent underweight in bonds,” says Danske Bank’s chief strategist, Henrik Drusebjerg.

What is the significance of Donald Trump contracting COVID-19?

“Markets initially reacted with a minor sell-off in US equities due to increased uncertainty, but we expect that the overall impact on the financial markets will be limited. Another issue is the impact on the election campaign. Our main scenario is that Donald Trump will recover relatively quickly and be capable of returning to the election fray. When UK PM Boris Johnson succumbed to the coronavirus, public sympathy led to a strong, though relatively transient, increase in his popularity, and the same could potentially happen for Donald Trump.”

How great a threat is a second wave of corona outbreaks for the financial markets?

“Clearly, the more the coronavirus flares up again in the autumn and winter, the more the recovery in economic growth could drag on. However, we are not expecting widespread lockdowns this time around, but rather more local and targeted restrictions that should have a less negative impact on economic growth, plus we are getting closer to a vaccine day by day. We therefore do not fear a repeat of this spring’s meltdown, though the coronavirus will still likely leave its mark on the financial markets for better or worse.”

What will be the key factors for the financial markets in the year’s final quarter?

“As well as the coronavirus we are of course closely monitoring the US presidential election, which may produce brief periods of turmoil. However, in the bigger picture we do not expect the outcome of the election to have any great significance for economic growth and the financial markets – though the two candidates of course have policy differences. Joe Biden wants to raise corporate taxes, among other things, which equity markets will not look on kindly. On the other hand, Joe Biden is seen as more predictable and cooperative, which is positive, so the outcome of the election could also have significance for the US-China trade dispute, which is still bubbling below the surface.

“The upcoming reporting season, which kicks off in the US in mid-October, will also be interesting to follow. Equities are currently expensive in P/E terms – in other words, the price investors pay per unit (DKK, EUR, USD, etc.) of earnings. This is because equity prices have risen a lot since bottoming out in March without corporate earnings having risen by a corresponding amount, so solid earnings figures and positive announcements from companies that can justify the high valuations will be important. However, we can see that companies have generally been good at cutting costs during the corona crisis, and that should give earnings an additional boost when sales pick up.

“Last but not least, we are closely following the macroeconomic numbers. Here, we would like to see further progress along the road to economic recovery, though setbacks along the way are likely. Non-farm payrolls in the US disappointed last week, with fewer new jobs created than expected – and unemployment in particular provides a good picture of how hard the coronavirus has hit economies. In the US, unemployment rocketed from less than 4% to almost 15% in the spring, and while around half those people who lost jobs have been rehired, a normalisation is still a long way off and will be a long, hard slog. Furthermore, we do not believe that US politicians will agree the long-awaited new fiscal relief package this side of the US election in November, which could weigh on markets in the shorter term.”

What is your investment focus right now?

“While we are aware of the short-term uncertainties, investors should also look further ahead and envisage how the world might look after the US election, a resolution of Brexit and the launch of a vaccine against the coronavirus. As the economy shifts up another gear, more cyclical sectors may stage a comeback after suffering considerably during the corona crisis. Cyclical sectors like Financials and Industrials typically perform best when economies are expanding, and we expect to see an expansion in the course of the coming year that could produce particularly attractive return opportunities in the financial sector. We recommend that investors begin gradually positioning their portfolios for this scenario now.

“We also continue to see an attractive, long-term return potential in tech stocks, which are benefiting from strong structural growth, even though there will undoubtedly be periods when other types of equities perform better. September’s equity price falls in the US, for example, were largely due to a shift away from tech stocks, which weigh heavily in the US equity market, over to more cyclical equities.

“Despite current uncertainties about the fiscal relief package in the US, we generally expect that central banks and politicians will be ready to support economies further if necessary, while the extremely accommodative monetary policies of the central banks have provided hitherto unseen levels of liquidity in the global economy. This liquidity has to be placed somewhere, and given that many bonds have very low or negative expected returns, we continue to expect that new liquidity will flow into equity markets. That is part of the reason why we expect reasonable returns from equities over the coming 12 months.”

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