The Navigator provides insight into stock market events with an outlook.
Market review
Following the “Corona shock” in the first quarter, a significant recovery began at the end of March with the major expiry (derivatives markets). As emotional as the markets appeared during the correction, the recovery in the second quarter seems equally irrational to many market participants. Unprecedented state interventionism, coupled with expanding central bank balance sheets, provided initial support to the markets. However, this support could become a burden on growth over time. Our free market system (capitalism) is increasingly falling into the clutches of the state – and will consequently be less free. Sooner or later, we will learn to live with the coronavirus. However, the tendency for administration to expand and demand payment through compulsory levies reduces the by-definition scarce, finite capital needed for the next wave of innovation and the resulting growth.
All stock markets experienced a strong recovery in the second quarter.
Interest rates came under pressure due to central bank measures and the demand shock (bond prices rose accordingly).
Regarding individual sectors, technology stocks benefited most. There’s no stopping it – everything seems to be going digital! Looking back at history, such a phenomenon is nothing new. Time and again, during a wave of innovation – as is currently the case – a race for relatively scarce capacities emerges: everyone must or wants to be part of it sooner or later to remain competitive. The so-called boom is often followed by disillusionment, the crash (bust). Nevertheless, technology stocks are in focus and have reached new highs, regardless of the Corona crisis.
The energy sector recovered from an unprecedented slump. The oil price (WTI) fell below zero with the expiry of the futures contract in April, specifically to USD -37.63 (April 20, 2020). Currently, the price is back at USD 39.95. This unprecedented price movement was due to a peculiarity of the American oil market: tanker offloading and pipelines converge at the Permian Basin, and due to the Corona situation, there was a lack of demand for oil, while extracted oil could only be diverted to storage or tankers to a limited extent due to this single, and thus scarce, point of access. What remained were investors or generally holders of futures contracts who could not take physical delivery of oil and thus could only sell the contracts.
Generally speaking, most sectors are still trading below the levels seen before the “Corona correction”. However, investors who kept their nerve during this emotional period and at least did not sell, were able to collect dividends and, thanks to the recovery, close relatively close to the old highs.
Precious metals, and gold in particular, already experienced increased demand in the first quarter. In the second quarter, demand for the precious metal for uncertain times increased – the shock runs deep, and the drumbeat of the gold bugs can be heard far and wide. Not that holding gold makes no sense. Gold has its place in every portfolio – we believe that those who already hold it should only buy more on weakness, and currently, we tend to favor gold mining stocks.
In summary, the second quarter was a correction of the emotionally driven downturn from the first quarter. The markets are – as we will see in more detail in the market technicals section – on their way to a new equilibrium.
Interest rates & capital markets
Interest rates once again came under pressure. As with every crisis in recent history, central banks are helping by providing sufficient liquidity, i.e., lower key interest rates and other supportive measures, to prevent even greater dislocations. New additions include funds from the Treasury, where governments have directly granted loans or made direct payments (and partly provided guarantees). With the crisis, there was – as usual – a flight to safe-haven assets, such as US government bonds. Lower-quality bonds suffered similarly to the stock markets – and recovered similarly.
Deflationary tendencies are discernible, although market economists and pundits disagree on this. Inflation or deflation will likely remain the dominant theme for the foreseeable future.
Market technology
In the second quarter, stock markets were able to continue their recovery phase and temporarily recoup about 4/5 of their losses (MSCI World Index). For technology stocks, and thus on the Nasdaq, prices are already higher than before the Corona crisis. With the renewed flare-up of new cases in June and weak consumer figures, markets generally came under some pressure again, but the temporary upward trend remains intact.
Towards the end of the quarter, an interim recovery began more or less simultaneously with the expiry week for options and futures. We assume that the markets will retest the lows. What follows is highly dependent on the course of the pandemic and, consequently, on the measures taken by governments regarding the economy. If the lockdown continues longer, we will see further new lows. Should the economy reopen and at least gain some momentum, we might have already seen the lows.
This upward trend appears more advanced in the USA than, for example, in Europe, where, technically speaking, the expansion should still be in its strongest phase, meaning it has relative catch-up potential.
Percentage of DAX Index Stocks Above the 200-Day Moving Average / (click on graphic for enlarged view)
Percentage of S&P 500 Index Stocks Above the 200-Day Moving Average / (click on graphic for enlarged view)
The rally is – as in previous years – primarily driven by a few (if not very few) stocks. This recovery since the Corona crash also still leaves smaller-capitalized stocks behind. One could say that the large-cap stocks are favored – and especially growth stocks such as technology titles.
Outlook
Black or white, positive or negative – that’s roughly the current sentiment regarding market development. So-called bulls and bears are known to shape price discovery on stock exchanges, but today, with the bleak outlook of economists and the strong rally we have recently seen on the markets, this constellation appears particularly pronounced. However, the current constellation can certainly make sense. The markets have fulfilled their task of finding the right price quite well: The virus brought the economy to a halt, resulting in significant revenue losses as a direct consequence. Interest rates are coming under pressure due to excess capacity on the one hand and the demand shock on the other. Deflationary tendencies are emerging. Nevertheless, stock markets were able to recoup immediate price setbacks, anticipating that in the future, due to a shortage of investment alternatives, more will have to be paid for a unit of future earnings. However, the immediate future is likely to continue to be driven by fear and greed – though hopefully not as pronounced as during the peak of the Corona crisis in March. If the various government programs to support the economy expire (if not extended), the removal of this dampener and the impact of reality will present another test for current prices. It is to be feared that over time, the activities of central banks and now also states to support the economy will erode confidence in our market system and currencies. Real assets, such as stocks, represent good value; if bought cheaply, money can also be made from them.
This upward trend appears more advanced in the USA than, for example, in Europe, where, technically speaking, the expansion should still be in its strongest phase, meaning it has relative catch-up potential.
“There is nothing so disastrous as a rational investment policy in an irrational world.” — Maynard Keynes
EDURAN AG
Thomas Dubach