The summer will soon be fading. Global equities have risen further in July and the first half of August and are now around the levels seen at the start of the year, with the IT sector still firmly in the lead.
Fixed income markets, too, have continued to normalise. When the panic over corona peaked in the spring, bonds at the riskiest end of the spectrum, such as emerging market and high yield bonds, tanked, but they have since recouped much of their losses.
Can investors look forward to further market growth – and what will determine direction going forward?
In Danske Bank, we are maintaining our modest overweight in equities to capture any potential upside but remain cautious. Danske Bank’s chief strategist, Henrik Drusebjerg, and investment strategist Lars Skovgaard Andersen highlight the key themes likely to affect your return in the time ahead:
1. More focused fight against the coronavirus
The virus remains a threat, but the response has changed. After the near complete lockdowns earlier this year, we are now seeing a more focused approach to new corona outbreaks, with some restrictions being reintroduced in affected areas.
The coronavirus is clearly still rampaging through several countries around the world, but a more focused approach to combating the virus means economies are not being completely closed down and so can continue to function – albeit at a lower level of activity. This is also the picture we expect to see going forward until a vaccine becomes available, and solid progress appears to have been made here. Nevertheless, markets will likely remain sensitive to the news flow on both vaccine progress and the further developments in the spread of the coronavirus.
2. What did the reporting season teach us?
Earnings were better than expected over the summer reporting season, but investors were harder to impress. That was the overall conclusion on the recent slew of financial reports – not least in the US.
Most companies in both the US and Europe beat analyst expectations. However, in the US, that was rewarded less than normal, indicating that a good deal of positivity has already been priced into equities and that there is considerable uncertainty ahead.
Guidance – in other words, a company’s expectations for the future – has become more important for investors. Expectations are currently running high for corporate earnings growth in 2021, so guidance will be a test of these expectations. Hence, this autumn, not only earnings figures but also future expectations are what could make or break the rebound in equities.
That being said, companies have generally been good at cutting costs during the corona crisis, so they are now leaner. This means that as the economy picks up again, we can expect rising sales to add more to corporate bottom lines than before.
3. Tense political situation
Politics have not taken much of a holiday this summer. In the US, the parties are negotiating a new economic stimulus package, and a deal here could boost US equities.
Meanwhile, US-China tensions have ratcheted up again on the back of US claims about Chinese hacking and the subsequent closure of the Chinese consulate in Houston, plus Donald Trump has threatened to ban the popular Chinese video app, TikTok, in the US on fears that it could provide Chinese authorities access to data on US users. However, these actions have limited economic impact and are currently of no great concern to us. The measures should to a large extent be viewed as domestic political manoeuvring by Donald Trump ahead of the US presidential elections in November.
In Europe, Brexit negotiations on the UK’s future relationship with the EU have largely stalled and the risk of a hard (no-deal) Brexit has increased. The EU agreed a recovery fund to support the corona-hit European economy, but as payouts cannot start until 2021, the deal will be of little help to short-term growth in Europe. European equities have underperformed and the political risk premium will likely remain high.
4. Weaker dollar opens opportunities
The US dollar (USD) generally acts as a safe haven and strengthens in times of turmoil. However, recent expectations of global economic growth have helped weaken the dollar against many other currencies, making an interesting case, not least, for emerging markets.
A weaker dollar makes servicing USD-denominated debt cheaper for emerging markets, while commodity exporters get higher prices for their goods in local currencies. All else being equal, this should improve the economies of these countries and lead to falling risk premiums on equities and bonds from emerging markets – and thus potentially higher prices.
Accommodative monetary policy from the US central bank and very low interest rates in the developed economies may further accelerate the flow of capital into emerging markets in a hunt for higher yields.