The divergence between market performance and economic data in recent weeks has many investors asking whether we are seeing the beginning of real recovery or just a strong bounce in a bear market.
News flow has indeed been good and markets have responded robustly to that. But the danger is that while headlines are painting an optimistic picture of a rapid V-shaped recovery, there is still a long way to go for economies that are only starting to emerge from expensive lockdowns.
At Goodbody, we do believe there has been a turn in the cycle and we are optimistic about it. However we have some caution that much of the good news is priced in. So we are looking for further evidence to gauge the strength of the recovery before becoming more aggressive.
That’s why we are not chasing into cyclical stocks at this point. We prefer instead to be very selective in allocating to high-quality growth companies at this stage while waiting for more clarity to develop.
Here are three things we are tracking closely:
- Consumer behaviour
The key to a sustainable global economic recovery is the consumer – especially in the US. The question we are asking is: what happens as economies open up further? Will we start to see a return to pre-Covid trends or will the virus come back in a second wave? Whether consumer spending bounces back depends on the answers.
We are cautious in the short term. It may seem like we are in the middle of a sharp recovery, especially when looking at sentiment indicators, which have improved a lot from their lows in late March and early April. However, we need to allow hard data to catch up to where the market is before feeling more comfortable and we see little opportunity for short-term moves up.
- Euro area stimulus
Europe is a source of good news for a change, in contrast to the Great Financial Crisis when it was often the source of problems and uncertainty. The coordination and pre-emption we have seen so far have been very good developments for markets and for the euro.
The ECB stands ready to do what is needed by expanding is bond-buying programme and euro members are on the verge of agreeing debt mutualisation for the first time to support a €750 billion stimulus fund. Perhaps more surprisingly, the German government has agreed its own €130 billion fiscal stimulus package – a dramatic departure from habitual conservatism - which includes generous subsidies for electric vehicles.
Two factors that are important here: 1) Europe is more export-oriented than the US, especially towards Asia, which means domestic stimulus has a smaller effect on growth and 2) the sectoral distribution is skewed towards heavy industry, especially motors, where the long-term challenges are significant.
- Inflation or deflation?
We have not had to worry about inflation for many years. In fact, massive quantitative easing in the last decade did not move inflation numbers at all. In the short term, deflation due to recession is the more obvious worry right now.
However, the combination of significant fiscal stimulus and extremely loose monetary policy could change this in the longer term. Wage data is usually the signal of impending inflation and for now there is no danger of upward pressure there. We think this is more of an issue heading into 2021, though.
