Global equities saw strong gains last week. Markets gained as much as 5.5% in local currency terms, although the increase was a rather smaller 3.0% in sterling terms as the pound strengthened against a weak dollar to $1.27. The strong performance was down to the market’s growing belief in a V-shaped economic recovery which was fuelled by two main developments:
First, US employment posted a surprise gain of 2.5m in May, rather than falling another 8m as had been expected, on top of the 20m decline seen in April. The unemployment rate also fell back to 13.3%, rather than head up to 20% as had been feared. This is undoubtedly good news and coming months should see further improvement in the labour market.
However, it is early days yet and the unemployment rate, even after this decline, remains higher than it ever reached in the global financial crisis. The real test for the economy will come as government support programmes are wound down over coming months. It is far from clear how easily the newly unemployed will find jobs again even if lockdowns continue to be relaxed.
Second, Europe, which had been lagging behind other regions in its stimulus efforts, has caught up considerably. The ECB last week increased its quantitative easing program from €750bn to €1,350bn. Moreover, hard on the heels of the EU Commission’s move to put in place an EU recovery fund, Germany has now launched a sizeable fiscal stimulus of its own.
The economic backdrop is clearly improving and will continue to do so if a re-tightening of lockdowns is avoided. However, the big question is whether it will continue to improve as fast as the market seems to believe. Global equities are now up close to 40% from their lows, in what is the fastest recovery ever, and only 6% below their February high. The typical gain, by contrast, seen in the first three months of a bull market is 20% and even over the first twelve months is only 35%.
Equity valuations also point to equities having rebounded too far, too fast. Even if one looks through the sharp hit to earnings this year and focuses on next year’s likely rebound, price-earnings ratios now look high. The global forward P/E ratio is up to 17.5x, a 16-year high.
Fear of missing out – and quite a few investors have missed out as the sharpness of this rally has caught most people by surprise – could yet carry equities higher near term. But, with markets now well ahead of the economic reality, a correction remains on the cards over coming months.