What to expect until the end of the year
After a turbulent first half of the year, the capital markets have recently returned to calmer waters. First the COVID-19 pandemic brought the markets down and then the central banks and governments did all they could to support the economy (or the stock markets) and prices soared again. The good news is that the stock market is trading significantly higher than in March and April. The bad news is that the year 2020 is not yet over. What to expect until the end of the year?
Emotions such as fear and greed will continue to reinforce trends on the financial markets. Moving times are imminent. Not only will the US presidential election in November bring volatility, but the negotiations on Britain’s withdrawal from the European Union and the development of the global pandemic will keep markets on edge. A closer look implies that the stock market is still expecting a faster recovery than economic data suggest. The dynamics of the economic recovery however has slowed down.
The central banks’ response to the pandemic
Central banks are doing everything they can to prevent a long recession. Despite these unpreceded interventions, we believe that the world economy will take many years to recover because of the COVID-19 shock. In addition, the trend towards WFH continues. This will hurt providers of commercial property. This central bank money is pure oxygen for the stock market but only to a limited extent for the real economy. The economy has been stabilised, but this liquidity is preventing an urgently needed structural adjustment of companies. Companies that should have disappeared are being kept alive.
The ECB did not announce any further softening of monetary policy at its September meeting. However, banks can continue to take advantage of the PEPP (Pandemic Emergency Purchase Programme) launched in March. The ECB is likely to leave the interest rates unchanged for a longer period of time and make future changes to monetary policy through other channels.
Across the pond, the US Federal Reserve is trying to tackle the crisis by revising its interest rate strategy. Based on the observation that the US Federal Reserve has missed its own inflation target of 2% in the past, the Fed Chair announced that the Federal Reserve would adopt a more flexible approach to inflation in the future. Specifically, the so-called “average inflation targeting” is to allow inflation rates of over 2% over a certain period, provided that it had previously traded below the target value of 2% for a longer period of time.
China as the engine of a post COVID-19 recovery
China will play a leading role in the recovery of the world economy. Based on data published by governments, China’s debt is lower than in the Euro area. This gives China more room to maneuver to support the economy. China has a long-term vision and wants to become a geopolitical and technological leader. However, we also see a geopolitical battle between the two superpowers. Furthermore, the USA is trying to push back China’s claim to power. That is why tensions will continue and this is a burden on the US economy. In the meantime, China is increasingly regaining strength after the COVID-19 shock. In September, the world’s second largest economy recorded the strongest increase in imports for this year. The rising demand for imported products suggests that the domestic economy, which was severely weakened by the outbreak of the pandemic in the first half of the year, is now getting back on track – boosted by stimulus packages and increased investments by the government.
Impacts of the US election on the global economy
Turning to the presidential election that will take the stage for the next weeks. We can see that US President Trump has done many things that have pleased the equity market, and should he be re-elected, the aggressive rhetoric towards China will continue. However if Biden is elected, then milder tones will certainly be adopted. For the financial markets both candidates offer potential positive influences. In the short term, there could be price setbacks as a result of a victory for the US Democrats with the associated higher corporate taxes for US corporations. However, the decisive factor is the monetary support of the Federal Reserve, which will remain unchanged for the nearby future. Moreover, the US Democrats are expected to inject even more money into the economy than the current ruling US Republicans. Furthermore, not only Trump has a domestic bias, Joe Biden has also presented a kind of “America First” programme, which clearly privileges US companies over foreign companies. Much to the delight of the stock markets.
Impacts on the investment strategies
For the investment portfolio, we recommend a more cautious approach. In addition to a probable acceleration of new COVID-19 infections in major economies during the winter months, we see the main economic risks in the future relationship between China and the US. For Europe, there is also the risk that the trade talks between the EU and Great Britain will fail, resulting in disorderly Brexit. Against this background, an increase in market volatility in the fourth quarter is expected.
As mentioned above, according to the central banks’ guidance, key interest rates should remain at current levels in the medium term. The credit premiums on corporate bonds, which are still higher than pre-crisis levels and the resulting increase in interest rates, represent an opportunity in our view, although selection is more important than ever. Accordingly, we continue to focus on attractively valued corporate bonds and recommend to hedge interest rates selectively.
Finally, we expect a further significant rise in the price of gold. Today inflation is not a problem. However, that may change in the long run, for instance if there is a problem on the supply side, supply chains stop working and globalisation falters. Then the prices of some products could suddenly rise. Inflation is already higher than long-term interest rates. That speaks for gold. We do not see real interest rates turning positive in the next few years. That will continue to drive the price of gold.