markets & economy | june 30, 2020
Global Markets Quarterly Update
Second Quarter 2020
Global equity markets recorded their best quarterly gains in decades as economies began to reopen and massive fiscal and monetary stimulus boosted sentiment.
Liquidity conditions improved, and bond yields stayed near record lows as central banks supported markets through corporate and government bond purchases.
A resurgence of the coronavirus in the U.S. weighed on sentiment in June, but new treatments and hopes for an early vaccine may have supported markets.
Stocks rebounded in the second quarter, with the S&P 500 Index recording its best quarterly performance since 1998, while the Dow Jones Industrial Average jumped the most since 1987. Within the S&P 500, consumer discretionary, technology, and energy shares led with total returns (including dividends) in excess of 30%, while utilities and consumer staples shares recorded much smaller gains. The tech‑heavy Nasdaq Composite Index reached record highs and easily outperformed the other benchmarks, and the Russell 1000 Growth Index nearly doubled the return of its value counterpart.
Bond returns were more muted, with the yield on the benchmark 10‑year Treasury note ending the quarter near where it began. (Bond prices and yields move in opposite directions.) Riskier bonds performed well, however, as investors greeted high levels of corporate issuance with robust demand. The Federal Reserve also supported the sector through its corporate debt purchases.
Investors Discouraged by Resurgence of Coronavirus Late in Quarter
Progress in the battle against the coronavirus boosted markets early in the quarter, with infection rates, hospitalizations, and deaths beginning to decline in early April in New York and other hard‑hit areas. The turnaround encouraged the nation’s governors to begin the gradual reopening of businesses and public facilities, while Boeing, automakers, and other major firms resumed manufacturing operations in late April.
After coasting lower for several weeks, however, the national number of daily diagnosed new cases began to climb in June and reached new highs by the end of the quarter. On June 11, the S&P 500 suffered its biggest one‑day sell‑off since March 16, as investors appeared to react to recent reports of increasing numbers of cases—and, more tellingly, hospitalizations and higher positivity rates—in Arizona and Texas. As the quarter came to an end, governors in both states and several others announced either reversals or delays in reopening plans.
Throughout the quarter, markets also appeared to react to reports of progress in developing treatments and a vaccine for the coronavirus. On April 17, stocks jumped after unofficial reports surfaced that Gilead Sciences was having success in U.S. trials of a potential treatment, remdesivir, although investors later appeared disappointed when Gilead’s results showed that the drug was only having a moderate impact on seriously ill patients. In June, sentiment seemed to get a lift from a major study showing that a common steroid drug, dexamethasone, helped save lives in serious COVID‑19 cases, marking the first treatment to have a demonstrable impact on reducing the fatality rate. Dr. Anthony Fauci, the nation’s top infectious diseases official, later told a congressional committee that a vaccine was a matter of “when and not if” and that he was “cautiously optimistic” that one would arrive by the end of the year.
Surprise May Jobs Rebound Boosts Sentiment
The overall tone of economic data also improved throughout the quarter and may have helped offset coronavirus fears. The signal event appeared to be the May jobs report, which was released in early June and showed that employers added back 2.5 million positions in May, defying consensus expectations for a decline of around 8 million jobs. Instead of rising to nearly 20% as forecast, the unemployment rate dropped to 13.3% from 14.7%. Retail sales also rebounded in May, and several indicators suggested a recovery in manufacturing.
Conversely, escalating tensions with China resulted in periodic volatility and may have restrained the quarter’s gains. In early May, President Donald Trump said in an interview that he was prepared to “terminate” the phase one trade deal with China if the country did not follow through on its pledge to buy more U.S. goods. New White House restrictions on U.S. firms doing business with Chinese telecommunications giant Huawei Technologies further unsettled investors, as did Beijing’s approval in late May of legislation restricting Hong Kong’s autonomy.
The MSCI Europe Index rebounded more than 15% in the second quarter, bolstered by massive monetary and fiscal stimulus, countries beginning to reopen their economies, and optimism surrounding potential coronavirus vaccines and treatments. France’s CAC‑40 Index and Italy’s FTSE MIB Index surged about 17% in local currency terms, while Germany’s Xetra DAX soared more than 28%. The UK’s FTSE 100 jumped almost 9%.
Core eurozone and peripheral government bonds produced positive returns, fueled in part by the European Central Bank’s dovish policies and nascent optimism surrounding a possible recovery. Asset prices were also supported by the prospect of a Europewide rescue package. Peripheral assets also reacted positively to signs that an economic recovery may strengthen in the second half of the year.
Merkel Sees Quick Accord on Eurozone Recovery Fund
European Union (EU) leaders began discussing a EUR 750 billion coronavirus recovery fund proposed by the European Commission (EC) as part of its next seven‑year budget. The EC would borrow from the market and distribute two‑thirds of the funds in grants and the rest in loans, meeting some of the objections lodged by member states. German Chancellor Angela Merkel said she expected leaders to resolve their differences at their July meeting. T. Rowe Price International Economist Tomasz Wieladek says this budget proposal is a workable compromise that addresses a lot of political sensitivities at once, which makes it more likely that all EU countries will agree to it sooner rather than later. He also believes that the European Central Bank (ECB) will still need to keep ensuring that peripheral bond yield spreads remain low in the medium term.
Many developed EU countries began easing border controls designed to contain the coronavirus, but continued restrictions and health concerns are still expected to curb tourism and business travel. In France, President Emmanuel Macron lifted most of the remaining lockdown restrictions and said he would focus on rebuilding the economy. UK Prime Minister Boris Johnson announced that pubs, restaurants, and hairdressers will be able to reopen on July 4, provided that they adhere to safety guidelines.
Data Suggest Economy Is Bottoming
As lockdown measures eased in May, monthly economic data began improving earlier than expected, suggesting that the record slump in Europe was bottoming and raising hopes of a rapid recovery. The flash IHS Markit Eurozone Composite Purchasing Managers’ Index surged to 47.5 in June from 31.9 in May, the second‑biggest jump in the survey’s history. German and French business confidence recovered at record rates in June, although they were still well below pre‑pandemic levels, national surveys showed.
Earlier in the quarter, data showed that the gross domestic product in the common currency zone shrank sequentially in the first quarter by 3.8%. Economic contractions in Spain, France, Italy, and the UK were also much sharper than expected. Second‑quarter readings are expected to be even worse, as most lockdowns started after early March and economies will reopen gradually.
ECB and BoE Expand Emergency Bond‑Buying Programs
The ECB increased its pandemic emergency bond‑buying program by EUR 600 billion to EUR 1.35 trillion, extending it until at least June 2021 and pledging to reinvest proceeds from maturing bonds until the end of 2022. Some 742 European banks borrowed a record EUR 1.31 trillion under the latest tender from the ECB’s targeted longer‑term refinancing operations.
The Bank of England (BoE) enlarged its bond‑buying program by GBP 100 billion and left its key interest rate at a record low of 0.1%. Governor Andrew Bailey also held out the prospect of interest rates staying at 0.1% for a considerable time.
Governments Pursue Fiscal Stimulus
Germany’s ruling coalition agreed to a EUR 130 billion stimulus package, exceeding the top end of consensus expectations by 30%. The UK is also taking further steps to shore up a recovery. Prime Minister Boris Johnson said the government would fast‑track GBP 5 billion of spending on infrastructure works. UK Chancellor of the Exchequer Rishi Sunak will unveil his next plans for the economy on July 8. Meanwhile, the Italian government approved a long‑delayed economic stimulus package worth EUR 55 billion. The measures, following an initial EUR 25 billion package introduced in March, include a mix of tax breaks and grants for businesses and households and incentives to help the tourism sector.
Japanese stocks produced strong gains but lagged most developed and emerging market benchmarks in the second quarter of 2020. Within the Japanese market, growth stocks outperformed value stocks by a wide margin, and small‑caps generally posted stronger gains than large‑caps. Backed by historic levels of fiscal and monetary stimulus, the equity rally offset much of the ground lost during the sell‑off in February and March. Although Japanese stocks underperformed in the second quarter, they remain ahead of many developed regions for the year‑to‑date period.
The yen marginally strengthened during the period versus the U.S. dollar and traded at JPY 107.93 per dollar at month‑end. The yield of the 10‑year Japanese government bond fell into negative territory in April but moved just above 0% for most of May and June and finished the period at 0.032%.
End of State of Emergency Lifts Market Sentiment
Gains in the Japanese market were driven by historic levels of fiscal and monetary stimulus and improving sentiment as the spread of the coronavirus pandemic slowed. Prime Minister Shinzō Abe announced near the end of May that he was lifting the state of emergency for the remaining five prefectures that were still on lockdown orders. The seven‑day moving average of new coronavirus cases in the country fell from more than 500 in April to below 100 in June, although there were signs of an uptick at the end of the period as more Japanese citizens resumed normal activities.
BoJ, Government Commit to Additional Stimulus
After initial stimulus measures in March, both the Bank of Japan (BoJ) and the Japanese government announced additional actions in response to the economic damage caused by the coronavirus. At its monetary policy committee meeting in late April, the BoJ decided to remove its annual quota for Japanese government bond purchases in favor of unlimited purchases as warranted. The central bank, in a surprise move, also said it would approximately triple its purchases of corporate bonds and commercial paper to about JPY 20 trillion annually from JPY 4.2 trillion and JPY 3.2 trillion, respectively. As expected, long‑ and short‑term policy rates were unchanged, and the BoJ’s outlook report reflected significant downward adjustments to its economic forecast due to the global pandemic.
Meanwhile, the government committed to a fiscal spending package (equivalent to at least USD 1 trillion), which included payouts to households and small businesses, to help mitigate the pandemic’s impact on the world’s third‑largest economy. However, as a result of the deficit spending, S&P Global Ratings downwardly revised its outlook for Japanese government debt from positive to stable, but the ratings agency kept the country’s credit rating at A+.
Exports Plunge Amid Coronavirus Shutdowns
Economic data released during the period largely reflected the effects of the coronavirus shutdowns and were expected to be weak. However, the drop in some key metrics was worse than expected. Japan’s Finance Ministry reported that the country’s exports declined 28.3% year over year in May as global demand plunged. Vehicle exports dropped by more than 60% during the period, and total Japanese exports to the U.S. also fell by about half.
A more current indicator of sentiment released later in the period improved, but details were mixed. The au Jibun Bank Flash Japan Composite Purchasing Managers’ Index moved higher in June, reflecting the increase in economic activity following the lifting of the country’s state of emergency. However, all of the improvement was due to the services sector, which rose from 26.5 to 42.3 (readings under 50 indicate contraction), whereas the manufacturing sector remained roughly unchanged at 38 as output and new orders showed little improvement.
Chinese equity markets rallied on growing evidence of a domestic economic recovery. The blue chip CSI 300 Index rose 13.0%, while the benchmark Shanghai Composite Index gained 8.5%. The technology and health care sectors outperformed; consumer stocks performed broadly in line; and the energy, telecommunications, and utilities sectors posted negative returns.
An outbreak of new coronavirus cases in Wuhan and in Beijing during the spring had surprisingly little impact on markets, and China’s public health experts appeared confident that they could control the secondary outbreaks relatively quickly. Political relations with the U.S. remained fragile, and tensions arising from China’s new security law in Hong Kong led the U.S. to revoke its special trade privileges for the city at month‑end. However, both countries reaffirmed their phase one trade deal, while high‑level talks in Hawaii were described as constructive.
The yield on China’s sovereign 10‑year bond gradually increased to end the quarter at 2.90% on increased supply following fiscal policy stimulus measures announced earlier this year. Domestic fixed income investors were reportedly disappointed by the central bank’s reluctance to cut interest rates or required reserves more aggressively. China’s currency, the renminbi, initially weakened on worries that the trade deal with the U.S. might unwind but subsequently stabilized after President Trump reaffirmed support for the deal and ended the quarter broadly unchanged against the U.S. dollar.
Positive Second-Quarter Data Confirm Recovery Underway
Economic indicators in recent months have shown that major parts of China’s economy were recovering from the coronavirus crisis at different speeds: The industrial sector and supply side of the economy were the first to recover, with the consumer and services sectors lagging.
Recent data in China, however, have largely painted an encouraging economic picture with no major setbacks, defying forecasts of a slow and uneven recovery. The Conference Board coincident indicator—based on “hard” data—rebounded in May to a level only 2% below its December 2019 peak. Monthly purchasing managers’ indexes were also positive, as manufacturing and nonmanufacturing composite indexes improved. The revival in industrial production continued into June as new export orders jumped, though they remained in negative territory. Housing was one of the few consumer‑driven sectors to see a V‑shaped recovery in the quarter. Low inventories combined with buoyant land sales are expected to underpin an increase in residential capital spending in 2020, providing a modest economic tailwind.
Most analysts expect China will return to positive economic growth in the second quarter after recording a record contraction in the first three months of the year. After widespread lockdowns ended in March, Beijing appears to be relying on fiscal policy focused on infrastructure spending rather than monetary policy to boost the economy.
Other Key Markets
Turkey Boosts Oversight of FX Transactions
Turkish stocks, as measured by MSCI, returned 18.81% in U.S. dollar terms in the second quarter and slightly outperformed the MSCI Emerging Markets Index, which returned 18.18%.
During the quarter, the central bank reduced its one‑week repo rate to 8.25% from 9.75% to stimulate the economy. It has also been working in tandem with the government to provide cheaper domestic funding for state budget purposes, for corporations, and for consumers. In addition to rate cuts, the central bank has engaged in quantitative easing by buying government bonds and is seeking to establish foreign exchange (FX) swap lines with other central banks.
A more concerning development, however, is that the Turkish government has been increasing oversight and moral suasion over FX transactions in an attempt to reduce Turkish lira volatility, keep FX flows under control, and enhance the country’s ability to become self‑financing. T. Rowe Price credit analyst Peter Botoucharov likens these efforts to a “soft form” of capital controls.
Some of the measures that Turkey has taken include:
The implementation of new rules from the Banking Regulation and Supervision Agency intended to encourage banks to issue more loans, buy government bonds, or provide foreign exchange swap lines to the central bank—and to penalize those banks that do not meet certain metrics.
An increase in taxes on foreign currency exchange transactions. About one year ago, the government implemented a 0.1% tax on such transactions; it was recently increased to 1.0%.
The suspension of licensing of asset managers whose foreign currency‑denominated securities make up at least 80% of total holdings. For asset managers with less than 80%, Turkey’s financial market regulator, the Capital Markets Board, will impose a 15% tax on their management of any such funds.
Companies with FX borrowings in excess of approximately USD 15 million must file a weekly report with the central bank, reporting their balances in line with another requirement by the Ministry of Finance, the Uniform Chart of Accounts.
Botoucharov believes that these government and central bank efforts could be somewhat effective in reducing lira and interest rate volatility and capital outflows, thus increasing the country’s self‑financing ability. However, he also believes that these measures will not fundamentally improve Turkey’s poor macroeconomic situation or reduce its large funding needs.
Brazilian Stocks Outperform Despite Political Turbulence
Stocks in Brazil, as measured by MSCI, returned 22.87% in U.S. dollar terms in the second quarter, easily outperforming the 18.18% return of the MSCI Emerging Markets Index.
Brazil’s currency struggled through the first half of May, however, with the real reaching new record lows versus the U.S. dollar amid low inflation and expectations for lower short‑term interest rates. The central bank slashed its benchmark Selic rate from 3.75% to 2.25% in two steps during the quarter. The real also sagged amid growing tensions within President Jair Bolsonaro’s administration. Additionally, President Bolsonaro’s lack of interest in quarantine measures—which arguably has led to Brazil having the second‑highest number of confirmed coronavirus cases in the world—behind only the U.S.—weighed on sentiment.
However, the real rebounded partially following hawkish comments on May 20 from central bank President Roberto Campos Neto. He acknowledged that the central bank had recently increased its interventions to support the real and expressed a willingness to continue using the bank’s foreign exchange reserves if needed to stabilize it. According to T. Rowe Price Sovereign Analyst Richard Hall, these hawkish comments were a noteworthy departure from his previous stance that Brazil’s currency weakness was not a concern.
After a strong start to the month of June, equities and the real encountered resistance as protests in various U.S. cities inspired anti‑Bolsonaro street protests in Brazil—something that Hall believes investors should keep an eye on, particularly because large street protests preceded former President Dilma Rousseff’s impeachment. If the rallies are big enough, Hall believes it could lead to an increase in impeachment talk.
Major Index Returns
Total returns unless noted
As of 6/30/2020
Figures shown in U.S. dollars
|U.S. Equity Indexes||2Q20||YTD|
|Dow Jones Industrial Average||18.51||-8.43|
|Nasdaq Composite (Principal Return)||30.63||12.11|
|Global/International Equity Indexes||2Q20||YTD|
|MSCI Emerging Markets||18.18||-9.67|
|MSCI All Country World||19.39||-5.99|
|Bloomberg Barclays U.S. Aggregate||2.90||6.14|
|Bloomberg Barclays Global Aggregate Ex-USD||3.38||0.61|
|Credit Suisse High Yield||10.00||-5.27|
|JP Morgan Emerging Markets Bond Global||11.21||-1.87|
Past performance is not a reliable indicator of future performance.
Note: Returns are for the periods ended June 30, 2020. The returns include dividends and interest income based on data supplied by third‑party provider RIMES and compiled by T. Rowe Price, except for the Nasdaq Composite Index, whose return is principal only.
Sources: Standard & Poor’s, LSE Group, Bloomberg Barclays, MSCI, Credit Suisse, Dow Jones, and J.P. Morgan (see Additional Disclosures).
What We're Watching Next
It seems likely that the second quarter will prove to have been the most challenging for economic activity and earnings. However, even as economies gradually and sometimes haltingly reopen, I believe a sustained recovery will largely depend on controlling the virus in the second half of 2020 and beyond. The key question for markets may now be how long it will take for companies to regain enough earnings power to justify current valuation levels while compensating investors for the risk that an economic recovery might not progress as rapidly or as evenly as expected.
To be sure, investors will need to monitor a host of other risks—some potentially worsened by the pandemic—in the second half. These include rising tensions between the U.S. and China, social unrest, and opposition to economic globalization. Even before the coronavirus disrupted their operations, the ability of multinational firms to exploit global economies of scale was being challenged by protectionist pressure. Now, after seeing the pandemic play havoc with supply chains, corporate managers themselves are likely to emphasize resilience over efficiency, even if it lowers profit margins.
Meanwhile, the economic and social consequences of the pandemic appear to have accelerated the rise of dominant technology platforms in retail, social media, streaming content, and remote conferencing. This trend is likely to widen the divide between industries and companies benefiting from disruption and those challenged by it. Going forward, disruption and the pandemic both should continue to favor the top five largest U.S. technology platforms, which, as of early June, accounted for more than 20% of market capitalization in the S&P 500 Index—greater than the bottom 340 index constituents combined.
Finally, it is notable that the rally in risk assets has been driven by massive doses of fiscal and monetary stimulus, which has set the stage for a tug of war between ample liquidity and the collapse in earnings. Amid uncertainty, asset returns are likely to remain uneven across countries, sectors, industries, and companies. In a fast‑changing environment, we believe investors will need to be able to generate fundamental insights, look at the full opportunity set within sectors and industries, and prioritize the most attractive opportunities in order to be successful.
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