US investors will come back from a long holiday weekend to familiar market conditions: risk ON. The new week started with a bang as Asian stocks as well as European and US index futures rallied sharply overnight, before extending their gains once Europe opened for trading...
At the time of writing, the indices were off their best levels but still holding near the day’s earlier highs, which meant that indices on Wall Street were set to gap higher at the open. Gains for the European indices were not as spectacular as China, but still ranged between a good 1.9 to 2.4 percent. All sectors were positive with cyclicals outpacing defensives on the constructive risk tone. Stocks exposed to China such as carmakers and luxury goods were among the leaders. In the UK, housebuilders such as Persimmon, Barrat Development and Taylor Wimpey all rose more than 5% each, supported by reports the Treasury was planning to increase the property tax threshold to as high as £500,000.
Chinese markets surge again
Investors certainly look like they believe China, the world's second biggest economy, will lead a global recovery judging by the stock market performance there. After last week’s 5.8% gains, the Shanghai Composite Index surged by another 5.7% on Monday, even as coronavirus cases continued to rise in the US and other places while new flare ups have forced renewed lockdowns in some areas. Investors are hoping that with the death rates falling and the global economies reopening, a strong economic recovery is on the horizon because of the decisive policy response from the major central banks and unprecedented actions by governments to the pandemic.
Economic data point to recovery
To be fair, we have seen some surprisingly strong macro pointers post lockdown, such as US jobs and retail sales, supporting the v-shaped recovery narrative. We need to see a continuity of this trend to keep the markets at these lofty levels. Today’s European data releases certainly pointed to further improvement, even if not all the numbers topped expectations:
- Eurozone July Sentix investor confidence -18.2 vs -10.4 expected, improving from -24.8 in June
- Eurozone retail sales +17.8% m/m in May vs. +15.0% expected and -11.7% in the previous month
- German Factory Orders +10.4% m/m in May vs. +15.1% expected and -26.2% in April
- UK June construction PMI 55.3 vs 46.0 expected, rising sharply from 28.9 in May
So, Eurozone retail sales and UK construction activity surged back due to pent up demand, while investor confidence and German factory orders both improved but at a slower pace than expected. Meanwhile, today’s main data coming up in the afternoon is the ISM Non-Manufacturing PMI, expected to have risen to 50.0 from 45.4 previously.
BUT are investors unrealistically too optimistic?
The rallying equity markets suggest investors are very optimistic about the economic recovery post lockdown. While some of the optimism certainly makes sense, one could argue the markets may have gotten ahead of themselves given the current situation and many risks facing investors in the months ahead.
Stock investors will soon start finding out exactly how the lockdown has hit company profits, with the second quarter reporting season due to kick off. I think the markets will focus more on forward guidance than companies’ performances in Q2. If a large number of companies project pessimism in their forecasts, then the stock market rally may finally come to a halt.
There is also a risk that the economic rebound may stall once the impact of pent-up demand wanes. Employers might not be too keen to hire aggressively while the threat of a second wave of coronavirus is still out there. Granted, we have seen a big jump in US job gains over the past two months. But employment there is still well below pre-pandemic levels, and the situations in many other countries are similar.
Other risks that investors will face include a second wave of covid-19 infections, renewed trade friction between the US and China, and a no-deal Brexit. Meanwhile, the impact of vast stimulus programmes announced by governments and central banks during the height of the pandemic will diminish.
So, while stocks look rather bullish right now, things could potentially turn ugly in as early as a couple of weeks when the reporting season kicks off.
DAX looks constructive for now
Source: TradingView.com and ThinkMarkets
Despite the above macro concerns, I am bullish on the indices in the short-term outlook and from a technical point of view, because the indices have been making higher highs and higher lows. I will be quick to drop that view as soon as the markets show a clear reversal sign. But indices, such as the DAX, above, continue to print bullish price action for now.