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SystematicEdge Monthly Market Overview May 2020

Market context:

The market rebound witnessed in April continued in May on the back of positive market sentiment as countries around the world began to reopen their economies. We believe the positive sentiment is largely driven by investors’ fear of missing out on the market recovery, despite clear signs that global economic activity has plunged into recession. In Europe, Italy, Spain, France, and the UK seem to have passed the pandemic peak with the number of new confirmed cases falling. By contrast, countries in Latin America, in particular Brazil, Mexico, and Peru, have experienced a sharp increase in the number of cases, while daily new infection rates continued to rise in Russia. In the US, although the peak appears to be behind us, the number of new confirmed cases every day remains relatively high. Most states have started to loosen their mandatory lockdown measures, allowing businesses to gradually reopen. Although this will have a positive impact on the economy, a number of health experts fear that it could further spread the virus.

1. Global Macro:

Official macroeconomic figures point to a global recession. In the US, real GDP (adjusted for seasonality and inflation) contracted at an annual rate of 5.0% in the first quarter of 2020, while corporate profits fell 14.2% and earnings per share for S&P 500 companies decreased 12.6% year-on-year. US jobless claims have now exceeded 40 million, representing the worst jobless rate in the US since the Great Depression in the 1930s. Nonetheless, equity market P/E valuations increased in May, with the S&P 500 index approaching its pre-Covid level. On May 29, the S&P 500 average P/E ratio was 26.4 (vs 21.5 a year ago) and the Nasdaq 100 average P/E ratio was 29.1 (vs 22.6). We note stock buybacks have shrunk significantly in the US amid increased political pressure and companies’ cash saving needs, while corporate earnings could be down 50% this year, which would exert stronger pressure on stock prices. Meanwhile, in response to the prolonged negative impact of the Covid-19 pandemic on the economy, central banks continued to inject liquidity and keep lower rates, while governments have maintained strong fiscal measures to help businesses and their population.

2. Financial Markets:

Despite the strong rebound already witnessed in the US equity market and signs of economic recession, investors are increasing their positions in US equities, in particular blue chips and tech stocks. We see this as a sign of investors’ positive expectations on the evolution of the pandemic amid hopes of finding a vaccine. Sector rotation is something to be watched in the coming weeks. While the Nasdaq 100 has almost reached its all-time high level of February, we note cyclical sectors, such as financials and industrials, have started to rebound and may benefit the most from the reopening of economies. Given positive momentum in the equity market and short covering in cyclical stocks and European stocks, equity prices are likely to rise further in the short term. Equity: Month to date the S&P 500 rallied +7.1%, Eurostoxx +4.2%; Hang Seng down 6.8% amid political tensions related to China’s national security law for Hong Kong. Fixed Income: 10-year US yield up 3bps in May to 0.65%. Emerging market government bonds in USD and local currencies rallied 6%. Corporate bonds rallied with high yield spreads further tightening. Currencies: USD remained relatively strong: EUR +1.3%, CNY -1.0%, BRL +2.7%. AUD rose +3.2% and safe haven JPY -0.8%, CHF +0.2%. Commodities: Oil rebounded following a historical low in April, precious metals further rallied: Oil +84.6%, Gold +3.8%.


COVID: The global economic recovery will largely depend on how the Covid-19 pandemic evolves and whether a second wave of infections leading to new lockdown measures occurs.

Wave of Bankruptcies: As businesses struggle to stay afloat amid the economic recession, bankruptcies may increase in the coming months, further aggravating the economic situation.

US-China tension: On a geopolitical level, US-China frictions will continue to have an impact on the global economy. China’s national security law for Hong Kong triggered new tensions between the US and China on the fear of jeopardizing the ‘one country, two systems’ principle.

Tech Bubble: On the equity side, the tech stock rally may turn into a bubble. Many tech stocks remain attractive to investors despite their particularly high P/E valuations, but other sectors, especially cyclical ones, may be favoured by investors as economic fundamentals start to improve.

4. Opportunities:

We believe cyclical sectors are well positioned to benefit from the future economic recovery. We remain positive on gold given the negative and near-zero interest rates environment. We also favour quality bonds, in particular banks’ investment grade bonds.