The constructive mood on the capital market is solidifying - investors are focusing on resilience and technology

07/22/2020 - Dr. Peter Oertmann
Market Insights

The midterm economic consequences of the Covid-19 pandemic still cannot be estimated. Clearly, the current episode will have a profound impact on the economy and will bring people's lives into a new normality. What exactly this new normality will then look like is also not yet clear. The global infection situation, especially in the United States of America and some converging countries, is a strong signal that the spread of the virus is far from under control. Add to this the developments in China and Hong Kong, the rapidly growing political division among the American population, the ever-recurring trade conflict between the USA and China, and a heterogeneous Europe that is constantly struggling to find common ground. None of this contributes to the stabilization of perspectives. All in all, the current way of thinking and acting of investors is characterized by enormous uncertainties.

In the last Market Insight (on 16 June) we concluded that the capital markets have definitely overcome the panic mode and believe in a return of economic growth by 2021 at the latest. Despite the continuing difficult global situation outlined in the first section, the positive trend on the equity markets has become even stronger in recent weeks. On July 20, the global stock market index MSCI World was only about 1.7 % below its value at the beginning of the year - almost as if nothing had happened. The currently measurable implicit volatility on the American stock market is around 25 %; although this is slightly higher compared to historical values, it is no indication of fragile circumstances. The fundamental reasons for the impressively rapid recovery from the pandemic shock and the robust demand for equities over the past weeks were discussed in detail in our latest Market Insights: Investors' long-term thinking, combined with exorbitant market liquidity, massive economic stimulus packages worldwide, the hope that a vaccine will soon be available, and the apparent rediscovery of equity shares as a real investment opportunity.

The constructive attitude of market participants makes the stock market quite resistant to the news flow at the moment. Nevertheless, investors are dealing with the historical crisis and its possible consequences in a differentiated manner. This is shown by a closer look at the classic safe havens for investment capital, the currency markets, and style preferences on the stock market. Here are a few facts:

These few highlights of selected price changes since the beginning of the year clearly illustrate that capital allocations in the current environment are made in a very sophisticated way: Investors hold large amounts of macro hedges such as gold and government bonds in their portfolios, distinguish between countries and economic areas in terms of their crisis resilience (weakening of USD, GBP and BRL against EUR) and focus on growth and technology stocks in the equity markets.

As in the previous Market Insights, we conclude by taking a look at selected interest rate differentials, since the prevailing expectations of market participants and, in particular, their current attitude towards systematic risks can be read off in a transparent and economically meaningful way. We base our analysis on interest rates in the US dollar and in the highly liquid US bond markets. The US TED Spread, the US Credit Spread and the US TERM Spread are examined during the pandemic phase thus far, together with a classification in the historical context.

Illustration 1: Difference between the interest rate for financing in US dollars on the Euro money market with a3-month term and the interest rate of a US Treasury Bill with a 90-day term.
Period: 1 January 2019 to 20 July 2020. Data source: Bloomberg.
Illustration 2: Difference between the average interest rate on US corporate bonds in the BAA credit rating category (medium-rated debtors) and the interest rate on US Treasuries.
Period: 1 January 2019 to 20 July 2020. Data source: Bloomberg.
Illustration 3: Difference between the interest rates on US Treasuries Bonds with 10 years maturity and US Treasury Bills with 3 months maturity. Period: 1 January 2019 to 20 July 2020. Data source: Bloomberg.

Conclusion

The markets continue to demonstrate strength to the mostly shocking news from the global pandemic centres and also to the current economic data. The impressive resistance of equity valuations - which is sometimes interpreted as a disconnection from the real world - is based not only on growth hopes for the post-Corona period, but also and especially on structural factors such as enormous market liquidity, investment pressure from institutional investors and the preference for equity shares of real companies in the context of growing government debt worldwide. However, it will continue to be very volatile for a long time. At any time, investors should expect significant distortions in risk-bearing assets. Among the significant risks are a persistent inability of the US administration to effectively contain the first wave of the corona pandemic, or a possible second wave of infection in Europe with renewed drastic effects on social and economic life. The currently prevailing economic confidence may very rapidly come under scrutiny again and lead to revaluations on the stock markets. However, it is exciting to note that the markets already have a certain idea of the new normality. The criteria 'resilience' and 'technology' appear to be at the top of the list of guiding principles for commitments on the capital market.