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Testing times

The British government struggles with infection basics while markets lack conviction as accommodative monetary policy continues to drive asset price inflation.

Ongoing volatility in US equities has been a focus of market attention over the past week. Following heavy options-related buying of US tech stocks by short-term retail traders, which has fuelled a gamma-driven run-up in the Nasdaq over the past few months, a market correction may not seem especially surprising given the magnitude of gains over the summer.

It has recently been notable that volatility indicators, such as the VIX Index, have been climbing even as the market has moved to record highs. News that Softbank had also been throwing large sums into driving the gamma squeeze in stocks has meant that such a pullback had started to look overdue.

Nevertheless, against a backdrop of accommodative monetary policy, the desire to buy the dip seems to show little sign of dissipating. For now, it appears that we have witnessed a short-term correction within a bull market rather than the beginning of a rout which could dethrone the likes of Dave Portnoy and the Robinhood community of investors and day traders.

Vaccine disappointments in constrained economies

News that the Oxford Group’s stage three Covid-19 vaccine trials would be suspended did little to unsettle markets during the week, even though this came as something of a disappointment to those hoping for early vaccine approval.

Those closer to the pharmaceutical sector will observe that such suspensions and setbacks are quite commonplace with respect to vaccine development and it is possible that this setback will prove only temporary. However, with many vaccines entering clinical trials, there has been a widespread assumption that approval and deployment are just around the corner.

Were there to be a material delay, this could represent a significant disappointment to many at a time when economies are continuing to feel the pain of operating under restrictions aimed at slowing the pandemic.

British blunders

In the UK, the blundering Johnson Administration has continued to flounder with respect to its policy actions. Having exhorted the need for office workers to return to their desks last week, this week has seen the government rushing in the other direction, imposing nationwide restrictions on gatherings of more than six people as infections continue to climb in some regions of the UK.

Meanwhile, it appears that a severe shortage of testing kits means that the country continues to struggle with some of the basics, which were addressed in many other nations several months ago. ‘Operation Moonshot’, designed to massively ramp-up testing, has been met with derision, as public trust in its Parliament appears to plumb new depths.

At the same time, Brexit is starting to loom large on the horizon and this week’s announcements from Westminster that they are planning to break international law by reneging on elements of the deal with the EU, which was agreed last year, has heightened a sense of national anxiety.

With former Conservative prime ministers aghast at these developments, there is a growing sense that a ‘Cabinet of Incompetents’ is steering the UK in a dangerous direction and this has the scope to continue to weigh on UK assets and the pound.

It is possible that we are witnessing (hand-fisted) negotiating tactics and a Brexit trade deal will yet be struck with the rest of the EU, as logic and common sense would appear to dictate. Yet as the deadline approaches, there is scope for things to get uglier in the short term and a ‘No Deal’ outcome cannot be discounted – even if this creates substantial economic damage in the process.

Lessons from Scandinavia

Covid numbers continue to grow across Europe, though with infections disproportionately skewed towards younger age groups, levels of hospital admissions and deaths remain low.

Meanwhile, it has been striking to see that Sweden appears to be performing much better, having moved closer to herd immunity, such that the limit on numbers gathering together is to be increased from 50 to 500.

More generally speaking, economic data across the EU continues to show some signs of improvement though the pace of recovery appears to have slowed after the initial rapid rebound following the end of lockdown measures.

This week’s ECB meeting contained few surprises with monetary policy remaining ultra-accommodative until the middle of 2021 at the earliest. Speculation whether the PEPP will be extended beyond next June could dominate discussions in Q1 next year, but for now it seems as if policy is on a relatively pre-determined course unless the ECB is forced to react to a new catalyst, or should euro strength cause it much greater discomfort than is currently the case.

Issuance uptick

The start of September has seen a sharp rise in the issuance of corporate bonds, though from a seasonal point of view there may be some suggestion that the volume of supply in the remainder of 2020 may be slightly less than some earlier estimates.

New deals have continued to be well-received, with little pricing concession once initial spread guidance has been revised tighter on the back of healthy order books. Index spreads for US and euro investment-grade corporates are unchanged in spread terms since the start of the month as a result.

In high yield, spreads have widened as energy-related names have underperformed on lower oil prices and higher equity volatility.

Meanwhile, emerging-market assets have been broadly rangebound at the start of the month, though external credit has continued to outpace returns from local currency bonds. Moves in FX have also been relatively rangebound, with the pound the notable underperformer.

Looking ahead

It remains difficult to build material conviction with respect to overall market direction. Accommodative monetary policy continues to drive asset price inflation. However, valuations are not compelling and uncertainty remains high. A more material drop in equity markets cannot be ruled out, though with many institutional investors expressing a degree of caution, it won’t be surprising if we see indices ‘climb the wall of worry’ in the absence of new news.

Meanwhile, the ongoing failure to add to fiscal stimulus in the US continues to risk an economic stall – something which seems quite probable in the UK, given discussions relating to budgetary tax increases and an end to the furlough scheme, which should see unemployment jump in the next couple of months.

A climate of uncertainty isn’t necessarily that conducive to taking much investment risk. For now, some patience seems warranted. There may be testing times ahead.