There’s something going on that’s not quite right
The summer has been positive for risk markets, as the decoupling between the global economy and financial markets continues. US equity markets have continued serenely and aggressively to ever higher highs. However, looking a little more closely at the drivers and breadth of the indices reveals a more nuanced picture.
The strength of the market is surprising given the risks still apparent in the world. The Covid-19 virus has continued to spread, with over 27.5 million recorded cases around the globe. Whilst the growth rate has slowed in more developed regions, the rise continues in certain emerging markets. As schools and businesses return to a version of normality a reacceleration of cases in the developed world would put pressure on policymakers to go further than local lockdowns.
Whilst the short-term high frequency economic data remains mixed, it points to a continued global recovery during the third quarter, but there is concern that the recovery is already diminishing. During the past month we have had confirmation of the dire second quarter GDP data, summarised below by the OECD.
Whilst it appears that the UK is an outlier in Q2 GDP growth, with the decline of 21.7%, economists believe this is due to the unusual way we measure health care prices in the UK and the reality is that the UK recession is much closer to the European average. The decline in the second quarter is still shocking and is the most since comparable records began in 1955. As it is the second consecutive quarterly decline in GDP, the UK has officially joined Europe, America, Japan and Australia in recession.
Global GDP is now expected to contract by between -3.5% and -4.7% over the year (prior estimates -2.9% to -4.2%). After a robust post-lockdown rebound in activity starting around May and early June, the pace of recovery seems to have slowed and stabilised between July-end and August. Since March we have had a significant global policy response of $20 trillion and 164 global rate cuts in 147 trading days. This has provided a huge support for risk assets, reducing real interest rates to zero or below.
Unemployment, however, remains a challenge. The OECD forecasting that the unemployment rate for the OECD countries could be 10% by the end of 2020, up from 5.3% in 2019. If there is a second pandemic wave the rate could go as high as 12%, delaying a jobs recovery until after 2021.
The latest unemployment data in the US has been slightly better than expected, but the unemployment rate remains elevated at 8.4%. Debate remains whether official figures are near reality as many people are being classified as employed even though they are absent from work. Negotiations relating to a new coronavirus relief bill continue to stall in Washington. Under the CARES Act an extra $600 per week of unemployment benefit was provided to workers who qualified for unemployment insurance. This extra financial support expired on 31 July. Since the beginning of August, those who have lost their jobs receive much less generous, unemployment benefits.
Within continental Europe there has been an increase in the number of Covid-19 cases, particularly in France and Spain. Governments have implemented targeted measures rather than blanket lockdowns. The euro area unemployment rate remains below 8% with governments persisting with their furlough schemes, which has allowed consumer confidence to return and retail sales to recover to pre-crisis levels. The creation of the €750bn European Union recovery fund has provided some further reassurance.
UK data has shown an improvement in consumption with growing retail sales. Services data shows expansion through August, however there is concern over unemployment here too. The latest (June) data shows the unemployment rate is at 3.9%, however it does not include the existing 3 million workers that are still furloughed. As the furlough scheme is withdrawn in October, the unemployment rate is set to rise.
The manufacturing data produced by China continues to suggest that the economic recovery is still in place however retail sales contracted by 1.1%, implying that the recovery has not yet trickled down to households.
Chief Investment Officer