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Signet Bank AS
Antonijas street 3,
Riga, LV 1010, Latvia
Phone: +371 67 080 000
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There is hardly a doubt that the past year has been one of the most challenging we have ever experienced. The year started out with us contemplating how high major equity indices can climb and why mid- and small-caps, as well as Emerging Markets, were not supporting the rally. That part of the brain exercise ended with market crashing in late February, oil futures seeing negative prices, high-yield bond market almost non-existent for days and precious metals falling like a rock. When we were approaching the climax of the correction, the fear was almost tangible, bringing back the memories of 2008 and early 2009.
In mid-March we, as well as many other market participants, were faced with one of the most difficult decisions – do we “buy risk now” as S&P 500 was approaching 2500 points with so many looking for prices in the 1800 area and below. Still, during our client event in late February we pointed out that Covid-19 was merely a trigger to many problems we already had and will not be “the ultimate destroyer” of the market, i.e. we are not into 2007-2009 scenario just yet. It was a hard and uncomfortable position at that time, but there we were. Gladly, many of our partners and trusted market participants with whom we went through many storms, were thinking the same, so we were not alone in our stance. Once the eruptions ended, the market was almost unstoppable.
We must be frank, we did not expect such a speed and force behind the rally off the lows. Yes, we were thinking of S&P 500 levels of 4000+ somewhere in 2021-2022 (as you can read in our previous memos) but now, it seems, we must be thinking of 5500+ as the point when this bull market finally dies.
And yes, news and cries and whining around did not help. How many times we saw event reports or market comments, which indeed triggered a dramatic market move, yet in the complete opposite direction? Millions of jobs lost? We spike 5% up. Senate passes the bill? We go 5% down. An honest market watcher will admit that he or she had seen this happen again and again and again just in 2020 (never mentioning the last 10 years). We said it quite often these years – sentiment trumps substance. It is still bull market after all. Yes, we saw the bearish side of it and it was ugly. Again, if you look at the February-March action in an unbiased manner it would almost seem as though the Fed action was causing the decline. Remember Alan Greenspan: “It’s only when the markets are perceived to have exhausted themselves (…) that they turn.”
With equity markets moving at maximum speed, the same risk-taking mentality seeped into the credit markets, propelling corporate bond indexes higher for both investment grade and high yield securities alike. Such sustained investor demand for corporate credit has pushed borrowing costs for issuing companies ever lower. This trend has benefited credit markets since April, when it became apparent that the Central Banks are determined to keep the train rolling. High-yield risk premiums are now back to pre-Covid levels, which seems mind boggling if you consider that corporate and high-yield bond issuance smashed all records.
Nevertheless, there are signs that the bond markets are starting to diverge into two different directions, as government yields are starting to rise; all the while, every other credit market has seen yields fall. Lately, the US Treasury long-term yields experienced the sharpest rise among developed market government yields, as opposed to German 10-year papers. If this divide continues and spills over to other sovereign bond yields, it could make it hard for the corporate credit markets going forward.
Meanwhile, EUR was marching forward and now EUR/USD 1.2500 mark seems to be just a matter of time. Any dip into 1.1800-1.2000 zone looks an easy “buy” opportunity. Dollar index however looks more suspicious (so do USD/CHF, USD/CAD and USD/JPY pairs) as it might produce a short-term dip with a steep reversal.
Metals were most certainly market’s “darlings” in 2020. We might even say that short deep dive in March gave them an opportunity to break over their respected resistance levels. Right now gold is on its way to 2000 and silver to high 30s. Of course, next 2-3 months will show how sustainable these projections are. We might see “the usual” prolonged consolidation period and then a quick aggressive rally with no visible corrections. Our only concern (especially with silver) is defining exit points in case something goes wrong.
Economic news and data were overshadowed by number of Covid-19 cases and conspiracy theories in 2020. As it stands now, we have manufacturing picking up at its fastest pace in more than six years in the US, extending an uneven recovery in the factory sector as consumer goods makers still sees weaker order flow and labor market shows that recovery has long way to go. Claims for benefits dropped to a seasonally adjusted 787,000 in the week ended December 26, however these numbers are roughly at the levels we saw three months ago with little indication of material improvement in the nearest future, with virus spreading aggressively and vaccination having barely started. Challenging conditions are reflected in US consumer confidence indicator as well – it dropped for a second straight month in December to a four-month low.
China continues its recovery although now is faced with rising cost pressure. The services sector has been slower to recover than the industrial sector as it is more vulnerable to the impact of stricter social distancing measures and those had been (again) tightened across Beijing, Hebei and Liaoning provinces. Due to somewhat robust demand in China, manufacturing activity expanded in Japan, South Korea and Taiwan, according to PMI surveys. However, slowdown in China’s factory activity as well as re-imposed curbs on economic activity across many countries will underscore the challenges the region faces. Activity in Eurozone increased closer to the end of the year. Germany was again the bloc’s driving force and in contrast to the dominant service industry, factories in the region have mostly remained open. In addition, Eurozone consumer confidence rose by 3.7 points in December improving to -13.9 in December from -17.6 in November. On Christmas Eve UK and EU officials approved post-Brexit trade deal thus ending more than four years of tense negotiations and safeguarding nearly a $1 trillion of annual trade.
For those who follow us, you already know that we lean to the bullish side and see 2021 as a great year for risk assets. Bumps on the road? Sure, but given the market structure does not change dramatically, we are heading to those 5500+ in S&P 500 somewhere in 2023. Still, as with all good things, this bull market will also come to an end. Remember the Bible – we do have a few years of “plenty” left, but we do urge you to remember what comes next.