Market Review 08/2020

The end of summer came with the second wave of Covid-19 (and new restrictions), protests and chaos in Belarus, new demonstrations of the Black Lives Matter movement and Hurricane Laura in Louisiana (the most severe in the state over the past 100 years), the conflict between Greece and Turkey in the Mediterranean and the worst economic data in history in many countries. Undoubtedly, an important point was also the new approach of the Federal Reserve System to its monetary policy. How did the market react? With total indifference and continuation of its way up, just as it did in April, May, June and July.

At the end of July, when the S&P 500 was approaching the 3,300 mark, we wrote, “surely, in the short term, it would be naive to expect the market to grow 20 percent with no retrace from current or slightly higher (5-7%) levels, therefore we can continue to wait for this market correction. Still, for the next 2-3 years our forecast is simple – a market that wants to grow will grow, and we will still see the S&P at 4000+ points.” Now, the index is knocking on the 3600 mark without any significant downturns.

European and US equity markets

Optimism returns to China

Stronger industrial sector and stock market, better business confidence and home and car sales combined to boost China’s economy. Factory activity expanded at the fastest pace in nearly a decade in August, supported by the first increase in new export orders this year. Caixin/Markit Manufacturing Purchasing Managers’ Index rose, marking the sector’s fourth consecutive month of growth and the biggest rate of expansion since January 2011. Profits of China’s industrial firms grew for a third straight month in July and at the fastest pace since June 2018.

Europe is in a gray area

The EU economy unexpectedly lost momentum in August. The slowdown undermines hopes for a V-shaped recovery – IHS Markit composite measure of private sector activity dropped to 51.6 in August from 54.9 in July. However, Eurozone’s economic sentiment grew in August for the fourth consecutive month – the indicator soared to 87.7 points from 82.4 in July. The new pick-up was driven mostly by higher optimism in the service sector. German economy contracted by a record 9.7% in the second quarter as consumer spending, company investments and exports collapsed – consumer spending shrank by 10.9% on the quarter, capital investments by 19.6% and exports by 20.3%, construction activity fell by 4.2%.

Benchmark 10-year bond yields

The US awaits new aid package

U.S. consumer spending increased more than expected in July – consumer spending, which accounts for more than two-thirds of U.S. economic activity, rose by 1.9% in July, after jumping 6.2% in June. It was lifted by purchases of goods like new motor vehicles, spending on healthcare, dining and accommodation. However, U.S. consumer confidence dropped to a more than a six-year low in August negatively impacted by the worries about the labor market and incomes. The Trump administration and Senate Republicans have been in regular contact over possible coronavirus relief measures and the Senate’s top Republican will most likely unveil a new bill shortly.

High Yield bond Indexes

Dollar continues to fall

“Did we finally see the end of US dollar?” – this is quite a popular question these days, as   EUR/USD charts do not look good for the greenback indeed. A well-defined downtrend from 1.60 dollars per euro back in 2008 now looks broken to the upside. However, EUR/USD needs to take out 1.26 mark on a weekly closing basis first. Market is long euro on record positions too, thus we suspect that 1.2000-1.2050 might be quite a tough region to go through without a larger pause. Shorter-term charts suggest that 1.2050 can be considered as an expensive level for the pair and a setback to 1.1700-1.1750 would offer a better level for long positions. Anything between 1.1600-1.1700 must be considered as cheap and for the upside bias to stay in place we should not go much lower than EUR/USD 1.15.

Gold price, USD/oz

A breather in precious metals

If July was a historical month for precious metals, August proved to be quite an emotional one with massive price swings giving many opportunities to the short-term traders. Gold finished the month with a warning that the five months long up-leg might had run its course. The indecisive candle on the graph points that we might see at least some consolidation or even a larger setback in the metal, so we recommend being careful in September. Should price close above 2080 at the end of the month it will definitely show that gold will look higher sooner rather than later. Silver chart looks more bullish as it is just halfway to its road to the all-time highs. Futures do not show any extreme long positioning in both metals, but attention they get in news headlines warn us that this market risks getting very crowded in the short term.

Caution is a friend in fixed income space

While yields in US are in «wait and see» mode, we find Germany bund chart to be very interesting. Almost a yearlong sideways price consolidation between 180 and 170 shows a decreasing amplitude, which normally occurs before next directional move. Just recently, German inflation data showed deflation (yet again) thus increasing risk for more ECB easing. The chart supports the idea that normally the presented price formation results in even higher prices (more negative yields). 185 and even 190 mark might be reachable in coming months putting even more pressure on German yields. Still, we think that this whole move (from 110 back in 2008) is approaching its terminal station and risks a sharp reversal in bund prices. If bund prices see a collapse through 169 mark without testing 185-190 region – this would signal a clear warning of a selloff in German debt.

Expected shift in Fed policy

Sovereign bond yields climbed slightly higher in August, leading up to the much-awaited annual Jackson Hole meeting of Fed members, and they did not disappoint. On August 27 the Fed Chairman J.Powell announced a major policy shift to “average inflation targeting.” That means the central bank will be more inclined to allow inflation to run higher than the standard 2% target before hiking interest rates. Inflation has been a constant disappointment for the Fed and with this new “policy,” they are throwing in the towel, which means low rates are here to stay.

Will the correction disappoint the bears?

Only a few weeks ago we trusted the 3400-3440 S&P levels to be the end-stop for this post-Covid rally, but now it seems we were too pessimistic. It is quite safe to say that 4000+ in the coming years now look more like 5500+ and the next correction (which we continue to wait for and therefore do not rush to increase our allocation to aggressive instruments) will be softer than expected. Now, market is not even thinking about “testing” the March lows, and we will most likely recommend starting to “build” long positions in the S&P levels close to 2900 or even higher. Of course, everything will depend on the market context but one thing is clear so far – this market will fall when it wants to, so we do not recommend bears to expect some “bad” news to suddenly change the sentiment of the market.