Global equities ended last week on a negative note and were down around 4.5% from their all-time high in early September. This morning, European markets have fallen back a further 3%.
The initial catalyst for the correction was a sharp run-up in the mega cap tech names which had left them looking extended and ripe for some profit taking. The FAANGs are now down over 10% from their highs and the froth looks like it has been blown off. While they may well remain volatile, there is no obvious reason for them to be at the forefront of any further sell-off. The fundamentals behind the tech sector remain strong and valuations are once again looking more reasonable.
However, the correction also clearly had its roots in the sheer scale of the rebound from March with global equities up some 50% from their low. This inevitably left markets vulnerable to a set-back, particularly with valuations at twenty-year highs.
The rebound in turn was in good part a result of the massive policy stimulus. The weakness late last week was triggered by disappointment that the US Fed had not extended its QE program. Even so, the Fed is still buying $120bn of bonds a month and remains a major support for equities. Indeed, it made it clear that it has no intention of raising rates for at least another three years.
The Bank of England also decided to leave policy unchanged last week. However, it kept open the possibility of cutting rates into negative territory next year if it should be necessary. An extension of its QE program later this year also remains quite possible.
All the same, the fact of the matter is that central banks have now spent most of their ammunition. Going forward, changes to fiscal policy will be much more important than any tweaks to monetary policy in shaping the economic recovery. And on this front, the news is not particularly encouraging as the markets may now be appreciating.
The US has failed to agree an extension of the fiscal stimulus measures which expired in July and may now not do before the November elections. As for the UK, Rishi Sunak is still resisting calls to extend the furlough scheme beyond October.
Just as important for markets will of course be Covid-related developments. This morning’s declines are a response to the second wave of infections now being seen in the UK and across much of Europe and fears that renewed social distancing measures/localised lockdowns could disrupt the economic recovery.
While the latest wave of infections is clearly a major cause for concern near term, it shouldn’t be forgotten that the longer term outlook regarding Covid is not all bad. Several late stage vaccine trials are now underway and a vaccine could quite possibly become available within a few months. Some countries, most notably China, also seem to have avoided a major secondary spike despite the reopening of their economies.
In short, the outlook remains quite uncertain. We believe it remains prudent at this juncture to maintain a broadly neutral stance on equities until some of these unknowns are cleared up – one way or another.