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SystematicEdge Monthly Market Overview July 2020

August 3, 2020

Market Context:

Global markets traded in a range in July, amid central banks’ continued liquidity measures. Equities only progressed in the US, led by large technology stocks. The US dollar kept weakening on a dovish Fed, leading the euro, yen and gold to appreciate in July. The accumulation of (expected) bad economic news, in particular unemployment, reduced earnings, and the recent wave of new Covid-19 infection cases, is making a V-shaped recovery, which had been thus far the implicit scenario priced in the global markets, increasingly unlikely.

Global Macro:

The Covid-19 pandemic continues to weigh heavily on the global economy, with new infection cases rising again in several countries where the spread of the disease seemed under control, while others, like Brazil and India, are still coping with the first wave. To support their domestic economies, the Fed, ECB and BOJ all confirmed they will keep their interest rates low in the foreseeable future. Despite the US second-quarter GDP plunging by a historic 32.9% (on an annualized basis), earnings from technology giants boosted the US equity market. Apple, Amazon, Alphabet, and Facebook stocks jumped as results beat Wall Street estimates, lifting futures on the S&P 500 and Nasdaq 100. Meanwhile, China’s manufacturing growth beat expectations, confirming the country’s recovery.

Financial Markets:

US equity valuations are currently trading at their highest multiples in terms of both forward price-to-earnings and price-to-book-value since the tech bubble of 2001. Market sentiment is becoming less positive as bad economic news accumulates and new Covid-19 daily cases rises again. As a result, equity momentum is fading.

Equity: Month to date the S&P 500 rallied 6.0%, Hang Seng +0.7%, while Euro Stoxx 50 lost 1.8%. Fixed Income: 10-year US yield decreased 12bps in July to 0.54%. Emerging market government bonds gained 3.4% in USD and 0.9% in local currencies. High-yield corporate bonds were up 0.8% in EUR and 4.7% in USD. Currencies: USD weakened in July: EUR +4.8%, CNY +1.2%, BRL +4.4%, AUD +3.4%; safe havens JPY +1.7%, CHF +3.5%. Commodities: Oil prices rose further while gold prices surged: WTI Oil +1.5%, Gold +10.9%.

Risks:

Covid-19: As the number of new daily cases increases in several countries, new lockdown measures would further delay the global economic recovery.
Bankruptcies: The number of bankruptcies has been rising amid the economic recession and is expected to worsen in the coming months, further aggravating the economic situation.
US-China tensions: US-China relations have further deteriorated following China’s adoption of the national security law for Hong Kong, while the US government ordered China to close its Houston consulate over concerns about economic espionage.
Tech bubble: The risk of a bubble on tech stocks remains strong, given high valuations.
US election: We expect the upcoming US presidential election to result in increased volatility in the financial markets. Democrats are looking to raise the tax rate on companies, which could put S&P 500 valuations under pressure.

Opportunities:

Despite US-China tensions, we believe Chinese equities have the potential for double-digit appreciation in the long run, led by secular growth sectors such as e-commerce, internet technology, healthcare, and education. Chinese equity valuations are the lowest among major equity markets while dividends remain substantial (4.5%). Gold is supported by the low-rate environment as well as the geopolitical uncertainty (US election, US-China tensions) and new wave of Covid-19 infections.