Global equities had their best quarter since 1998 in Q2 and started Q3 on a positive note. Markets could be choppier during summer, as valuations are rich in some leading sectors, seasonal liquidity is lower and many sources of risks remain: the spike in virus cases is forcing a number of US states to reverse the easing of lockdowns, a number of European countries are also seeing a rise in cases, Q2 reporting season will kick-off soon and the US Presidential election is set to become a significant source of uncertainty. Yet, many of these risks are mostly known to investors and the growth-policy tradeoff remains supportive of equities. Inflation may continue to be a topic of discussion but the lower for longer yield expectation is well anchored.
Despite the strong rebound in activity data, bond yields remain stubbornly low and seem to convey a much more cautious message than the bullish equity market. The ‘Fed put’ is perhaps misleading but it provides a safety net to equities – it has so far kept investors in fixed income and ‘safer’ bond-like parts of the equity market. Financial innovation contributed to the rally in shares since mid-March and cyclicals such as Banks rebounded too, but not as much as implied by surging PMIs. In short, rising yields appear to be the missing link to confirm the nascent reflation trade. The bottom line here is that if the US government requires substantial deficit finance, the Federal Reserve has the obligation to help finance the spending.
Ultimately, we could see things return to normal with a vaccine in spring 2021, but having gone through this virus, and a potential second wave in fall 2020, tastes and preferences will likely change for good towards working from home, e-commerce, e-services, mobile banking and other tech enabled disruption.
