Politics, economics and a pandemic: Equity markets under pressure

September saw profit-taking on equities amid concerns over COVID-19 as well as economic and political uncertainties. After rallying for five months, global equities fell in September. Further fiscal support measures are taking shape but slowly, central banks are lobbying for more haste.

After the rally, a correction in September

Early trading in September saw heavy profit taking, the
S&P 500 index having just set a new record high when it closed on 2
September, the same day it marked a rise of nearly 11% since the start of the
year. Labouring under substantial profit taking and certain technicalities, US
tech stocks were particularly hard hit, with the Nasdaq composite index
correcting by 10% between 2 and 8 September. These swings brought with them a
rise in implied volatility: The VIX index, calculated on S&P 500 options,
rose in a few days from 22 to 34, its highest since the end of June.

However, there was only limited contagion to other major
stock markets and other risky assets and the ‘risk off’ phase failed to really
take hold. Firstly, volatility eased and eurozone indices held up well for most
of the month; in Tokyo, the stock market even ended slightly higher. Secondly,
US equities rose at the end of the period, driven in particular by hopes of an
agreement in Congress on new fiscal measures.

Over the month, global equities fell by 3.4% (MSCI AC World index in US dollar terms). Coming after five consecutive monthly gains, the drop reflected concerns about the resurgence of the COVID-19 outbreak. The rise in the number of cases of contamination and hospitalisation led many countries to beef up social distancing measures to varying degrees: A re-imposed lockdown in Israel, local lockdowns in Spain, restrictions on public gatherings and shorter bar and restaurant opening hours in France, the UK and Germany in particular.

The threat of a second wave and responses like these
reminded investors of the reality of the uncertainties hanging over the global
economy – something they had chosen to ignore during the summer. Disappointing
activity indicators, particularly in the eurozone, fuelled investor concerns by
highlighting signs that the recovery was running out of steam after the
mechanical (and rapid) catch-up since May.

Against this backdrop, the renewed commitments from the
major central banks to maintain their highly accommodative monetary policies
for a very long time, or even to take additional measures if needed, failed to
fully reassure equity investors.

Better news in Asia

In Asia, the economic data of recent weeks has been quite
encouraging. Activity is returning to pre-pandemic levels in many sectors of
the Chinese economy and the pick-up in demand on Asian exporters is favourable.
Moreover, the epidemic appears to be under better control than in major Western
countries and other emerging markets. Emerging Asia’s better resilience helped
the MSCI Emerging Markets Index (-1.8% in US dollar terms) outperform developed
markets.

US equities underperformed other major markets in September. The S&P 500 Index lost 3.9% and the Nasdaq composite, 5.2%. This month’s decline, however, leaves the Nasdaq up by 24.5% year-to-date (+4.1% for the S&P 500). European stock markets also ended down: -2.4% for the EURO STOXX 50, which has fallen by 14.7% so far in 2020, penalised in particular by the difficulties of financial stocks. In Tokyo, the Topix index ended the month slightly up (+0.5%), supported by the Bank of Japan’s purchases and by the recovery in demand in Asia. The Japanese government’s change of leadership, which was quick and smooth, was seen as ensuring continuity in economic policy. At the global level, cyclical sectors, including some subsectors of technology, outperformed the rest of the market. Energy and banks posted the biggest monthly declines.

The ECB and a strong euro

The EUR/USD exchange rate, having peeped above 1.20 on 1 September, first stabilised at around 1.18 before heading towards 1.16. Market participants had envisaged that comments from members of the European Central Bank’s (ECB) Governing Council would put an end to the rapid appreciation of the euro underway since late May, when the exchange rate was below 1.10.

Market moves in September were a result of concerns over eurozone growth and the decline in equities that led investors to favour the US dollar. The EUR/USD exchange rate finished the month at 1.1743, down by 1.7% compared to the end of August. Even so, the euro appreciated in the third quarter.

Graph shows changes
in the EUR/USD exchange rate from January 2018 to September 2020.

Following the ECB’s monetary policy meeting on 10 September, there were no changes in key rates, asset purchase programmes or forward guidance. While this was largely expected, observers were disappointed on several points, and were left with the impression that the ECB’s stance was a little less dovish than expected.

This feeling was compounded by various rumours that some
members would have liked the upward revision of the GDP forecast to have been
better highlighted. An 8% drop in eurozone GDP is now expected for 2020, while
the figures published by the ECB in June showed a drop of 8.7%. This was mainly
due to a somewhat smaller decline in Q2.

The ECB’s reaction to the euro’s climb seemed low key. As is customary, the ECB has talked about the effects on inflation of a strong currency. However, its statements have remained muted and suggest the Governing Council is not too concerned about the euro hovering at around USD 1.18. Yet only the day after the meeting, several comments on this topic suggested dissensions among council members.

Against this background, expectations remain high for the
announcement in December of a further increase in the asset purchase envelopes,
or a reallocation between programmes – and this despite some comments giving
the contrary impression that the envelope of the PEPP (Pandemic emergency
purchase programme) may not be fully used.

A (cautiously) positive medium-term outlook

 The investor optimism that prevailed in July and August weakened in September. The difficulties encountered at the beginning of the month by US tech stocks spread to other risk assets, although without markets reaching for the panic button.

As signs of a second wave of the COVID-19 pandemic mount, investors seem to have suddenly become aware of the fragility of the global economy. After the slump in activity in the spring and the rapid rebound from May onwards, momentum has recently flagged.

In addition, as the US election approaches and Brexit negotiations enter the final straight, political factors will come more to the fore in the coming weeks.

And among these health, economic and political
uncertainties, there are likely to be delays in the adoption of new fiscal
support measures in the US and Europe. Equity movements could be erratic in the
short term even if a still rather cautious investor positioning is likely to
limit the downside.

In the medium term, proactive economic policies should
ensure a favourable economic and financial environment. The message from
central banks is clear: The monetary policies put in place will allow long-term
rates to remain very low for a very long time. Such an environment is
supportive for equities and risk assets generally. In addition, advances in
medical research should become more tangible over the coming months and help
boost economic agents’ confidence, which remains crucial for a sustainable recovery
that can spread across all sectors.

Beyond possible short-term headwinds, we remain cautiously optimistic and, depending on the signals sent by our proprietary market “temperature” indicators, we may look at bearish developments as opportunities to strengthen our equity position.

Any views expressed
here are those of the author as of the date of publication, are based on
available information, and are subject to change without notice. Individual
portfolio management teams may hold different views and may take different
investment decisions for different clients. This document does not constitute
investment advice.

The value of
investments and the income they generate may go down as well as up and it is
possible that investors will not recover their initial outlay. Past performance
is no guarantee for future returns.

Investing in
emerging markets, or specialised or restricted sectors is likely to be subject
to a higher-than-average volatility due to a high degree of concentration,
greater uncertainty because less information is available, there is less
liquidity or due to greater sensitivity to changes in market conditions
(social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Writen by Nathalie Benatia. The post Politics, economics and a pandemic: Equity markets under pressure appeared first on Investors’ Corner – The official blog of BNP Paribas Asset Management.